Inverse oil exchange-traded funds (ETFs), which are leveraged and can be highly risky, seek to short either a single energy commodity or a combination of several energy commodities. Examples of the types of commodities typically shorted by these ETFs include crude oil, gasoline, and heating oil. These ETFs gain when prices of the underlying oil-based commodities fall, which can occur due to either a drop in global demand or an increase in global supply.
Oil prices spiked earlier in the year following Russia's invasion of Ukraine, although they have since pulled back on concerns about a recession and ongoing geopolitical turmoil. The Organization of the Petroleum Exporting Countries (OPEC) and other major producers including Russia, an alliance collectively known as OPEC+, trimmed production output in early September, stoking more concerns about oil prices and supply. Russia's invasion of Ukraine, combined with bans on imports of Russian energy by the U.S., and its allies have exacerbated the supply situation.
Key Takeaways
- The best (and only) inverse oil exchange-traded fund (ETF) is SCO.
- Oil prices have risen faster than the broader U.S. stock market over the past year.
- SCO provides 2× daily short exposure to crude oil prices.
The U.S. inverse oil ETF discussed in more detail below is highly leveraged. Leveraged ETFs can generally be identified by the “2×,” “UltraShort,” “3×,” or “Double” label within the fund’s name. These funds use financial derivatives and debt to amplify returns; therefore, they are considered especially risky.
They are used mainly by highly sophisticated investors who have experience with the heightened volatility often associated with energy commodities and leveraged ETFs. By combining both inverse and leverage strategies, inverse leveraged ETFs are especially complex and risky instruments and should be avoided by less sophisticated investors.
Leveraged ETFs can be riskier investments than non-leveraged ETFs given that they respond to daily movements in the underlying securities that they represent, and losses can be amplified during adverse price moves. Furthermore, leveraged ETFs are designed to achieve their multiplier on one-day returns, but you should not expect that they will do so on longer-term returns. For example, a 2× ETF may return 2% on a day when its benchmark rises 1%, but you shouldn’t expect it to return 20% in a year when its benchmark rises 10%. For more details, see this U.S. Securities and Exchange Commission (SEC) alert.
Below, we look at one of the only inverse oil ETFs that trades in the U.S.: the ProShares UltraShort Bloomberg Crude Oil (SCO) ETF. There is a second U.S. inverse oil ETF, the MicroSectors Oil & Gas Exploration & Production -3x Inverse Leveraged ETN (OILD), which is very small and provides 3x inverse leverage. However, with an inception date of Nov. 8, 2021, it does not have a long enough history to be included in this article. Oil prices, as measured by the Bloomberg Composite Crude Oil Subindex, have risen 49.8% over the past year while the S&P 500 has posted a total return of -12.2%, as of Sept. 2, 2022.
However, neither the S&P 500 nor the price of oil is a proper benchmark for SCO, which is designed to meet performance goals over a single day, not over longer periods of time. SCO offers daily short exposure to crude oil prices through the use of futures contracts. It does not short stocks of oil companies. All numbers below are as of Sept. 6, 2022.
Inverse ETFs can be riskier investments than non-inverse ETFs because they are only designed to achieve the inverse of their benchmark’s one-day returns. You should not expect that they will do so on longer-term returns. For example, an inverse ETF may return 1% on a day when its benchmark falls -1%, but you shouldn’t expect it to return 10% in a year when its benchmark falls -10%. For more details, see this SEC alert.
ProShares UltraShort Bloomberg Crude Oil (SCO)
- Performance Over One-Year: -70.8%
- Expense Ratio: 0.95%
- Annual Dividend Yield: N/A
- Three-Month Average Daily Volume: 5,652,325
- Assets Under Management: $466.1 million
- Inception Date: Nov. 24, 2008
- Issuer: ProShares
SCO is structured as a commodity pool, a private investment tool structured to combine investor contributions for trading futures and commodities markets. The ETF seeks daily investment returns, before fees and expenses, that are two times the inverse (-2×) of the daily performance of the Bloomberg Commodity Balanced WTI Crude Oil Index, an index of crude oil futures contracts. The fund takes short positions on oil futures contracts, not the spot price of oil. It is currently shortfuturesthat expire in June 2023, December 2022, and December 2023. SCO may be used by sophisticated investors with a bearish short-term outlook for crude oil. The ETF’s leverage is reset on a daily basis, resulting in returns that are compounded when held for multiple periods. As mentioned, investors with a low tolerance for risk or with a buy-and-hold strategy should avoid this fund.
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