Betting on Oil Price Drop... Profitability is 'So-so'

[Asia Economy Reporter Junho Hwang] Although the number of investors betting on a decline in oil prices has significantly increased due to the sharp rise in international oil prices, concerns have been raised that the returns from betting on falling oil prices may fall short of expectations.

According to Daishin Securities on the 3rd, as international oil prices surged, a large amount of funds flowed into crude oil inverse ETFs in the domestic exchange-traded fund (ETF) market throughout this month. The ETF with the largest increase in assets under management as of the 1st was the KODEX WTI Crude Oil Futures Inverse, which attracted 532 billion KRW in funds. Following that, the TIGER Crude Oil Futures Inverse saw a net inflow of 363.5 billion KRW. Of the total net inflow of 1.757 trillion KRW into the domestic ETF market, more than half (50.96%) was invested betting on a decline in oil prices.

However, it is difficult to achieve as high returns as these investors expect. First, all inverse ETFs reflect -1 times the daily return of the underlying index. If oil prices continue to rise, losses can accumulate over longer investment periods.

In particular, both ETFs invest in futures and track the S&P GSCI Crude Oil Index ER as their underlying index. The "ER" at the end of the index name means that the costs and returns incurred during the futures rollover process are also reflected in the index. This implies that additional gains or losses may occur when rolling over futures contracts monthly. Recently, due to the sharp rise in oil prices, a contango situation has occurred where futures prices for contracts with later settlement months are lower than spot prices. In other words, for long-term investments involving multiple rollovers, even if oil prices decline, the returns of oil inverse ETFs may underperform the -1 times return of oil prices. This means expected returns decrease.

Although rare, since these products are based on commodity futures, the holding or replacement of contract months may change depending on market conditions. In 2020, when oil prices recorded negative values and showed extreme volatility, S&P took emergency measures to change the underlying index's contract month from June 2020 to July 2020 based on the situation at that time. This means that if investors expect a sharp drop in oil prices based on recent futures contract prices, actual returns may fall short of expectations.

Kim Haein, a researcher at Daishin Securities, analyzed, "Although it is a special situation, if investors expect a sharp drop in oil prices based on recent futures contract prices, oil inverse ETFs may not deliver returns as anticipated."