Thursday, February 12, 2009

Crude Indices and UCO/SCO

Another installment in the occasional series of posts about leveraged ETFs and oil. As mentioned earlier, I have discovered the bulk of my readers visit here looking for information on oil and their various ETFs, both levered and not. In an earlier long post on the ultras, I tackled the issue of volatility and compounding and their potential effects on performance of ETFs such as DXO, DTO and their ilk.

There is another related issue here and that is the tracking effectiveness of these ETFs with their benchmarks. And taking a step backwards from that issue, how do the various benchmarks perform in tracking NYMEX crude? There are two families of ultra ETFs for oil - ProShares (UCO/SCO) and PowerShares (DXO/DTO) - with the former using Dow Jones AIG Crude Oil Sub-Index (DJAIGCL) as its benchmark and the latter utilizing the rather verbose Deutsche Bank Liquid Commodity Index - Optimum Yield Oil Excess Return (DBLCI-OY_CL or DBOLIX).

I used EIA's data on Cushing WTI spot pricing (see link to the right) and checked the correlation of DJAIGCL and DBLCI-OY_CL closing prices with this. Unsurprisingly, the correlations are tight with DJAIGCL having a bit better correlation over the period 1/2/07 - 2/10/09. DJAIGCL had a 0.99597 and DBLCI a 0.985602. In the chart to the right, I also tossed in USO since it is probably the most widely tracked oil ETF and for most people, a proxy for crude pricing. You will also likely notice the NYMEX front and NYMEX 2-month average. This latter value was thrown in because it provides some contrast in periods of significant contango (such as now) and on days with huge squeezes (typically assignment days.) One thing of note is that the value of DBOLIX charted is the DBOLIX divided by 10 so as to make the scaling a little better.

So, at this point I think it is reasonably established that these two benchmarks are excellent trackers of Cushing WTI spot pricing.

The next question is how well do ultra ETFs and ETNs perform with respect to their stated goal of achieving +2x/-2x daily percentage moves of their benchmark index. I started with UCO and SCO in this analysis. (My apologies to all the fans of DXO/DTO - next post.) Part of the reason for this, is that open/close data is available for DJAIGCL going back much longer than what I could find for DBLCI-OY_CL. The flipside is that UCO and SCO have been in existence a far shorter time than their Power Shares counterparts. It's probably easiest to start off with a chart. The average absolute value track error for UCO since its inception is 3.61%. For example, if DJAIGCL moved 2% intraday, UCO should be expected to move +4% intraday. If UCO instead moved +7%, my terminology is that this is a +3% tracking error. For better or worse, this doesn't appear to be a systematic problem and the average tracking error is -0.16%. A few other statistics seem worth a passing mention: the correlation of UCO with DJAIGCL is 0.979 and the correlation of the intraday percentage change of UCO with tracking error is a negligible -0.11.

Moving on to SCO, here's the same chart on the same scale. Basically, similar behavior and a similar average track error of -0.312% and average absolute track error of 3.52%. And the other correlations of SCO with DJAIGCL and intraday percentage change on track error are: -0.798 and -0.02, respectively.

The lack of any correlation of the tracking error with the direction and magnitude of the intraday percentage change of the index implies there is little that can be done to anticipate them, even within a session. While these two funds do offer leverage, more often than not they fail at their stated goals of 2x or -2x the intraday percentage move of the target benchmark, DJAIGCL.

I’ll likely give DTO and DXO similar treatment in the next week or so.