Is Now the Time to Invest in Short Oil Funds?

by Susan J. Aluise | October 25, 2011 7:00 am

“Oil is like a wild animal,” oil tycoon J. Paul Getty once said. “Whoever captures it has it.” It doesn’t matter much whether that wild animal is a bull or bear: Investors who end up on the wrong side of black gold’s price volatility have their share of war wounds to show for it. Since it’s difficult to predict the future, getting a little protection from the ebbs and flows of oil prices is prudent — and short oil funds are one interesting play for wild times like these.

Here’s why: Oil prices have swung from a high of more than $110 a barrel in early May to $82 in August — and had inched back up to above $90 by Monday. Oil price volatility is extremely tough to manage, even for experts. Consider the airline industry, which saw its fuel bill skyrocket by $1 billion in the first quarter. But when prices fell, airlines’ fuel hedges went south, wreaking havoc with third-quarter earnings. Fuel hedge losses were enough to turn Southwest Airlines‘ (NYSE:LUV[1]) $205 million profit from the third quarter of 2010 into a $140 million loss for the same quarter this year.

There’s no magic 8-ball that can predict what direction oil prices are going. On one hand, Asian economies — particularly China and Japan — are getting back on track. On the other hand, Europe is not out of the woods yet in its debt crisis, and the dollar is gaining ground — both factors are likely to depress oil prices. A Libya without strongman Moammar Gadhafi could increase production, lowering prices. But the impact of a Libya under Shariah law could have unintended consequences for oil supply and production.

So how can short oil funds help investors when oil prices are so unpredictable? Short (or inverse) oil funds are a bearish play, designed to protect investors from a slide in oil prices — and a selloff in oil stocks. Here are four short oil funds to consider:

  1. United States Short Oil Fund (AMEX:DNO[2]). This ETF moves inverse to the percentage changes in the spot price of light, sweet crude oil delivered to the Cushing, Okla., oil hub. With $12.45 million in net assets, it is trading at $41.49 — more than 20% above its 52-week high. DNO’s year-to-date return is 2.65%.
  2. ProShares UltraShort DJ-UBS Crude Oil (AMEX:SCO[3]). This ETF seeks results equal to twice (200%) the inverse of the daily performance of the Dow Jones UBS Crude Oil Sub-Index. With $46.34 million in assets, it is trading at $48.64 — more than 37% above its 52-week low. SCO’s year-to-date return is 1.47%.
  3. PowerShares DB Crude Oil Double Short (AMEX:DTO[4]). This ETN offers twice the monthly inverse performance of the Deutsche Bank Liquid Commodity Index-Optimum Yield Oil Excess Return and the monthly T-Bill return. With net assets of $297.14 million, it is trading at $53.16 — more than 44% above its 52-week low. DTO’s year-to-date market performance is 14.13%.
  4. PowerShares DB Crude Oil Short (AMEX:SZO[5]). This ETN tracks the Deutsche Bank Liquid Commodity Index-Optimum Yield Oil Excess Return and allows investors to take a short view on the performance of the index. With net assets of $13.34 million, it is trading at $45.57 — up more than 22% above its 52-week low. SZO’s year-to-date return is 7.13%.

As of this writing, Susan J. Aluise did not hold a position in any of the aforementioned stocks.

  1. LUV:
  2. DNO:
  3. SCO:
  4. DTO:
  5. SZO:

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