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How to Play Oil Rally With Leveraged ETFs

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Oil price has shown a strong rebound this year and recovered about half of the losses made in the final quarter of 2018 despite global growth concerns and rising U.S. shale oil (read: Top ETF Stories of January).

The real optimism came from OPEC-led fresh crude output cuts, where major oil producers have agreed to curb production by 1.2 million barrels per day during the first six months of 2019 in order to tackle global supply glut and rebalance the oil market. The 14-member OPEC cartel has agreed to reduce its output by 800,000 barrels per day, while Russia and the allied producers will take off 400,000 barrels per day from the market.

Additionally, U.S. sanctions against Venezuela led to strong optimism in the space as it will sharply limit oil transactions between Venezuela and other countries, threatening to disrupt global trade flows. Further, falling OPEC production and Fed’s dovish outlook, which pushed the U.S. dollar down, led to spike in oil price. Notably, weak dollar made dollar-denominated assets cheap for foreign investors, potentially raising demand for commodities.

Per Reuters’ survey, oil supply from the Organization of the Petroleum Exporting Countries fell in January by the largest amount in two years. The OPEC has pumped in 30.98 million barrels per day (bpd) last month, down 890,000 bpd from December and the largest month-on-month drop since January 2017. Hopes over the trade deal between the United States and China have lifted investor sentiments.

The solid run-up in price has made January the best month-ever for the U.S. crude oil and the best month since April 2016 for Brent. Light oil has climbed 18.5% while Brent has gained 15.9% so far this year (read: 5 Reasons Why Oil Saw the Best January: 5 ETF Winners).

The combination of all these factors has increased the appeal for oil at least for the near term, fueling a rally in the energy space.

How to Play?

Amid renewed optimism, many investors have turned bullish on oil and are seeking to tap this opportunity. For them, a leveraged play on the commodity could be an excellent idea as these could see huge gains in a very short time frame when compared to the simple products.

Below we have highlighted several leveraged ETFs and the key differences between them:

ProShares Ultra Bloomberg Crude Oil ETF UCO

This fund seeks to deliver twice (2x or 200%) the returns of the daily performance of the Bloomberg WTI Crude Oil Subindex, which consists of futures contracts on crude oil. It has $467.8 million in AUM and trades in heavy volume of about 3.3 million shares a day on average. Expense ratio comes in at 0.95%. The fund climbed 39.3% in the year-to-date timeframe.

VelocityShares 3x Long Crude Oil ETN UWT

This targets the energy commodity market through WTI crude oil futures contracts. It seeks to deliver thrice the returns of the S&P GSCI Crude Oil Index Excess Return and has amassed $503 million in its asset base. The ETN trades in heavy volumes of around 6.8 million shares a day, though it charges a higher fee of 1.50% per year. The note has soared 62.4% so far this year.

ProShares UltraPro 3x Crude Oil ETF OILU

This ETF offers three times (3x or 300%) exposure to the daily performance of the Bloomberg WTI Crude Oil Subindex. The fund has amassed $131.1 million in its asset base and trades in solid average volume of 652,000 shares. It charges investors 95 bps in annual fees and has gained 61.8% so far this year (read: Wall Street Caps Best Month in Decades: 6 Top Leveraged ETFs).

UBS ETRACS ProShares Daily 3x Long Crude ETN

With AUM of $18.3 million, WTIU also delivers three times exposure to the daily performance of the Bloomberg WTI Crude Oil Subindex ER. It has an expense ratio of 1.45% and trades in average daily volume of 65,000 shares. WTIU is up 61.8% in the same timeframe.

United States 3x Oil Fund USOU

This fund provided three times the daily price movements of WTI oil, charging investors 1.00% in expense ratio. It has accumulated $27.1 million in its asset base and trades in a moderate volume of 70,000 shares a day. The ETF has risen 61.4% so far this year.

Bottom Line

As a caveat, investors should note that these products are extremely volatile and suitable only for short-term traders. Additionally, the daily rebalancing — when combined with leverage — may make these products deviate significantly from the expected long-term performance figures (see: all the Leveraged Commodity ETFs here).

Still, for ETF investors who are bullish on the commodity oil for the near term, either of the above products can be an interesting choice. Clearly, a near-term long could be intriguing for those with high-risk tolerance, and a belief that the trend is a friend in this corner of the investing world.

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