OOO – Backwardation

There has not been a great deal of talk what the effects of backwardation have on OOO so I am going to start a conversation.  Below is a list of WTI crude oil futures traded in the market with their respective prices. This ranges from futures with settlement in 27 days, right out to 2,452 days’ time.  For OOO, all we need to focus on is the top couple of rows.

These ETF’s typically have their capital in the front month (spot) contracts of the underlying.  When these come to expire, they HAVE to get out by selling and buy into the next month’s contract.  So based off these prices, they sell the spot month at $48.97, and buy the next contract at $50.54.  Then you find that the spot price has increased, but OOO will not move at all based on that move.  Then you get to the end of the second month, sell at $50.54 and buy the following one at $51.77.  The process goes on…

I have used an assumption of a static market (clearly it moves) but the principle is clear.  If you buy and hold OOO or any other oil ETF for that matter, the swings in underlying oil futures need to be greater than the effects of backwardation to see you come out in front.  That is why buying AND holding OOO (in my opinion) is a bit of a suckers game.  At least by writing some options (collecting income as per my previous posts) I have much greater chance of removing this effect.  Either that or you buy a long dated futures contract but there are complexities there to…

Having said all that, Saudi’s dropping bombs in Yemen helps everyone today!