Decline in Oil Markets Wallops ETFs That Bet on Energy Prices and Stocks

Exchange-traded funds that let investors bet on energy prices and stocks are among the most popular offerings, judging by their considerable trading activity, but some of these ETFs have been slammed by the steep declines in crude-oil prices.

"There simply is very little buying coming into the markets," said MF Global analyst Edward Meir. "With respect to crude, it is anyone's guess where we go from here."

PowerShares DB Crude Oil Double Long ETN, a exchange-traded note, shed more than half its value in the month ended Dec. 4, according to investment researcher Morningstar Inc. In three months ended Dec. 4, it was off more than 80%.

Oil Slick

Other ETFs and ETNs that give leveraged exposure to commodities and related stock sectors have taken similar hits from a correction in energy prices. The casualty list includes PowerShares DB Commodity Double Long ETN, ProShares Ultra Basic Materials and ProShares Ultra Oil & Gas.

While consumers have been benefiting from lower oil prices at the pump in the form of cheaper gasoline, U.S. Gasoline Fund is down more than 60% in the past three months.

Exchange-traded products linked to crude oil also have been caught in the center of the commodity storm, such as iPath S&P GSCI Crude Oil Total Return Index ETN, U.S. Oil Fund, U.S. 12 Month Oil Fund, MacroShares $100 Oil Up, PowerShares DB Crude Oil Long ETN and PowerShares DB Oil Fund.

Individuals have many choices when it comes to investing in the energy sector, and there are even offerings designed to bet against commodities.

Several products track energy stocks, such as the highly traded Oil Service HOLDRS. There also are portfolios designed to short, or bet against, oil and energy-sector stocks so investors can profit from market declines or to hedge other investments, and some of these bearish funds and notes provide leverage.

Check Under the Hood

Exchange-traded products have let individuals easily access commodities and other sectors without opening up a futures account, but investors should make sure to research them thoroughly before jumping in. For example, ETNs have come under pressure recently because they carry credit risk.

Also, some of the funds listed above use the futures markets to get exposure to oil and commodities prices. This is important because the oil markets are in a state known as "contango," in which longer-dated futures are more expensive than the spot price. Heavy contango may, at times, indicate a market perception of oversupply.

The bottom line is that funds that use futures need to continually rollover the contracts to maintain exposure. When markets are in contango, the funds post a loss on such trades.

This has been a source of confusion in recent years with the proliferation of ETFs and ETNs tracking oil and commodities.

Investors also need to be aware that gains on these products that invest in futures or hold physical commodities can be taxed at a higher rate than funds that invest in stocks.

Still, there is evidence that investors have been using the products to trade the volatility in oil markets this year.

Energy Select Sector SPDR Fund, ProShares UltraShort Oil & Gas and Oil Service HOLDRS were among the top 20 U.S.-listed ETFs by daily dollar volume in the third quarter, according to research from Morgan Stanley.

Oil and energy ETFs also had some of the highest levels of short interest relative to overall assets. Highlighting the scope of the action, many oil and energy-related funds can see their entire asset base turn over in a matter of days.