The rout in oil prices hasn’t just affected those firms that produce energy. It has also hit those nations that rely on oil for their life blood. Many of the nations in OPEC have been driven to the brink of insolvency by their stubbornness to keep oil pumping. At their last informal meeting, the cartel finally cried “uncle” as lower prices have crimped state budgets and balance sheets.
You can now add Russia to that list.
Receiving the vast bulk of its revenues from oil — and other commodities — Russia has continued to suffer in the wake of the downturn. The Russian economy is in shambles, and it has actually raised production — so it can sell more barrels — in order to even begin to keep itself a float.
Vladimir Putin finally threw in the towel.
It’s being reported that Putin has finally agreed to completely freeze production. Taking such a major supplier out of the equation will only see to surge the price of oil — in both the short and long term.
For those investors looking to bet big in the short term, the VelocityShares 3x Long Crude Oil ETN (NYSEARCA:UWTI) is the only way to go.
UTWI: Rising Oil Prices With Some Leverage
Given the short-term price action in oil — thanks to Russia’s production freeze — investors need short-term answers. Under that guise, leverage exchanged-traded funds (ETFs) are actually a good deal. UWTI is the most liquid of these funds betting directly on crude oil prices.
UWTI uses swaps, futures and other derivatives to take a long view on West Texas Intermediate (WTI) benchmarked crude oil. Specifically, UWTI bets directly on the next two months’ worth of NYMEX crude oil futures contracts. The ETF then uses a bit of leverage to provide investors with three times the daily return of its underlying index. So if crude oil moves up 1%, then UWTI should move up 3%.
It’s the easiest way to capitalize on Russia and OPEC’s recent decisions to cut oil production in order to boost prices and save their economies.
Now, using UWTI does come with a fair bit of risk. Perhaps the biggest is just how the leverage works. The ETF provides that exposure for a single day. That’s a key feature that leads to phenomenon called “volatility decay.” After the close of the day’s trading, UWTI resets itself to zero in terms of its daily gain. Over long stretches if time, the percentage moves in share price term can seriously become out of whack and actually lead to major losses. And the more volatile the market — as oil prices are- the bigger the volatility decay can be.
This is why leveraged ETFs of any stripe should only be used in very short term trading scenarios — ideally only for a day, or a week at most.
Another potential risk is the fact that UWTI and its sister inverse leverage ETF — the VelocityShares 3x Inverse Crude Oil ETN (NYSEARCA:DWTI) — are actually exchange-traded notes (ETNs). That means they technically are debt instruments and are “promises to pay” obligations issued by a creditor. In this case, Credit Suisse Group AG (ADR) (NYSE:CS). By using it, investors are adding credit risk to the oil price equation. Now, that risk is muted as the idea here is to “flip” UWTI shares, but it is still there.
Expenses for UWTI run an expensive 1.35%- or $135 per $10,000 invested. However, expenses are less of a concern for short-term products. Trading costs — thanks to its ample volume — make UWTI a cheap way to play rising oil prices.
UWTI Has the Most Bang For Your Buck
There are some other choices for investors — such as the 2x leveraged ProShares Ultra DJ-UBS Crude Oil (NYSEARCA:UCO) or nonleveraged United States Oil Fund LP (ETF) (NYSEARCA:USO) — to play the sudden surge in crude oil prices. However, neither of the two offer as much leverage as UWTI does.
In this sort of situation, the idea is to get in, get out and make the most possible money in the shortest amount of time. Under that framework, the VelocityShares 3x Long Crude Oil ETN has them both beat. You’ll get a higher return than UCO and USO, solely based on the extra leverage.
The key to remember is that this just for a single day.
The Bottom Line: Russia is looking to not only cut production, but freeze it outright. That’ll take a ton of supply off the market. For investors — or in this case, traders — UWTI is the best way to capitalize on that price action.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.