This piece was written for FT Alphaville by Gregor Macdonald, an independent energy analyst and investor based in Amherst, Massachusetts.
The CBOE kicked off the second half of 2008 with a new volatility product: the OVX.
The OVX will attempt to track the volatility of the most popular Oil ETF: USO, The US Oil Fund. As options players understand, sometimes the best bet is not on direction, but, on volatility itself. With oil’s stunning rise in the first half of 2008, the CBOE appears to have timed this product well.
And yet, the USO is not Oil. In fact, this ETF has experienced more than a few growing pains–er, tracking pains–since its launch in April of 2006. Back then, the crude oil futures curve was in contango. In other words, each successive month’s contract for oil was higher in price, than the preceding month.
This meant that USO, which flubbed by choosing to hold only front month oil, was forced to pay a higher price for oil contracts as they rolled forward each month, at expiry. Instead of Roll Yield, earned during backwardation, USO suffered capital erosion. This lead to some perverse outcomes, as USO’s share price would often flatten during oil’s rise.
But the managers of USO adapted to this problem. USO amended the structure of the fund, and started inching their way out the crude oil futures curve, holding oil futures contracts out 2-3 months. This has made the Roll more efficient. And so, for the past year or two, USO’s share price performance has hugged oil’s performance quite well.
So, will any of this effect the efficiency of the new product, from CBOE? Probably not. The new OVX actually tracks the options on the USO. Option activity on USO is quite heavy, and liquid. OVX therefore is a derivative of a derivative, if you will. And so in this regard, the CBOE may well have created a product both unique, and important.
Volatility in energy prices makes planning difficult, for all sorts of enterprises. The OVX could be useful, then, at a time when huge gaps still exist in the varying opinions on oil’s future. Simple hedging long, or short, Oil may not be enough, for many users.
One area impacted negatively by energy price uncertainty is Alternative Energy. Alternative Energy, like Wind and Solar, has to overcome the extra hurdle of volatile energy prices, when trying to attract investment. Could the OVX become useful, to investors in the Wind or Solar sector? As the OVX was only just launched this Tuesday, 15 July, we will have to update as we go along to see who, beyond traders, actually uses this new product.
Related links
“The mere fact that there is an oil VIX means we probably topped in oil” - FT Alphaville
