The volatility in crude oil trading has reached the highest levels since Lehman’s systemic crisis in 2008. Intraday swings of 5-10% are now de rigeur with OPEC and geopolitical headlines jockeying for narrative amid collapsing fundamentals.. but there is another, much bigger driver of this sudden chaos. As Reuters reports, the sudden liquidation of a $600 million triple-levered fund bet on falling prices wreaked havoc through the entire crude oil complex.
Intraday volatility in oil has been incredible to say the least…
But this week’s epic rips – in the face of dire data – was just “odd”…
Plenty of narratives were assigned but none made any sense. So what really happened? As Reuters reports,
Unknown investors in the VelocityShares 3x Inverse Crude Oil Exchange Traded Note (ETN) – which offers the ability to make a bearish bet on prices magnified threefold, with gut-churning ups and downs – bailed out early this week after jumping into the fund in January, ETN data show.
Some 1.8 million shares worth more than $602 million were redeemed on Tuesday, the largest outflow from the ETN in history, according to data from FactSet Research.
The selloff suggests that at least some big investors are betting that the worst of an 18-month oil market rout is over after U.S. prices fell to $26 a barrel last month for the first time since 2003. Trading activity has also jumped to the highest levels on record.
The DWTI note inversely tracks the S&P GSCI Crude Oil Index ER, which follows movements in the oil market. And because it offers investors three times the exposure, the impact on the underlying futures is magnified – as is the volatility in the ETN, whose price more than doubled in the first three weeks of January before halving again as oil futures rebounded.
The net asset value of the fund – one of a handful of exchange funds that allows investors to trade crude oil without the complexity of a futures exchange – fell from close to $1 billion to $417 million on Tuesday and to $322 million on Wednesday, according VelocityShares’ website.
As a result, the mass exodus likely forced the ETN’s issuer, Credit Suisse, to quickly buy back short positions as investors redeemed shares.
VelocityShares, a unit of Janus Capital Group, was unable to comment on the trading activity.
To unwind alone may have amounted to upwards of 40,000 futures contracts on Tuesday, according to estimates by analysts.
There is a day’s lag between when redemptions and creations are ordered and when they show up in share figures, according to Nadig, meaning that Tuesday’s flows were ordered on Monday, when oil reversed a three-day rally to close $2 a barrel lower.
On Wednesday, crude oil prices surged more than 8 percent to $32.28 a barrel, despite a seemingly bearish report from the U.S. Energy Information Administration showing nationwide crude oil inventories rose by 7.8 million barrels last week.
Volume in the March West Texas Intermediate futures contract surged on Wednesday to more than 777,000 lots traded, its second highest volume on record, according to data via ThomsonReuters’ Eikon. DWTI volume was also unusually heavy on Wednesday, with more than 1.9 million shares traded.
So that explains the sudden squeeze carnage yesterday…
And why today’s follow-through has failed as that unwind pressure disappears as DWTI’s NAV disappears.
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