USOI: Crude Oil Covered Call Fund Delivers

seekingalpha04-04

We had a bull rating on Credit Suisse X-Links Crude Oil Shares Covered Call ETNs, the covered call fund for crude oil futures.The bullish factors played out, and the fund has outperformed even the S&P...

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While the problems with blind covered call selling funds are not something we generally look past, the fundamentals were just too compelling. Commodity futures exposed funds also have some significant decay issues, and that is why we have historically only traded them from the short side. But here, we went the other way. We had 4 strong reasons to give this a buy and in hindsight, that was probably a setup for a \"Strong Buy.\" We look at how the trade has played out and why we are far more cautious today. Total Returns Since our buy rating, USOI has delivered 18.4% in total returns. Those returns include those hefty dividends you have been getting. On a relative basis, USOI did a little worse than the more famous United States Oil (USO). Covered calls give away some upside in strong trending markets, but here the overall lag was quite modest. USOI also did way better than the S&P 500 (SP500) as represented by SPDR® S&P 500 ETF Trust (SPY). Imagine oil beating SPY in the age of (bubble) AI. Data by YCharts All this played out in about 100 days, so your annualized gains were exceptional, with almost zero drawdowns. We now go over our reasons to move to a \"hold\" rating. 1) No Nearby Support From Department Of Energy Buying Around the time of our last article, we had seen some interest come in from the U.S. administration to fill in the depleted strategic petroleum reserves. This made sense from a trading perspective, as the Biden administration had sold millions of barrels at triple-digit prices following the Ukraine invasion. Refilling near the $70/barrel lows would mark a big victory. That was one key reason for assigning a bull rating on an asset class (funds on commodity futures) where we generally stay out. Our rationale was that worst case, we might hit $65/barrel and then the buying would provide a floor. Coupled with sold calls, what USOI engages in, the odds of a loss would be really low. With crude oil now mooning all the way to $85/barrel, that is completely out of the picture. We are not in Kansas anymore. 2) Speculative Position Changes One facet of investing or trading in commodities is that you have to know where the positioning is. This is primarily a zero-sum game so positioning matters a lot to make money. Back then, we stressed that long-managed money positions were extremely low, relative to their history. Futures Positioning From Previous Article This added confidence that a further selloff was unlikely. We have now rebounded off those lows. Data by YCharts These positioning reports lag the real-time changes. We are sure when they are next updated, it will show that this number is even higher. While we do not see this as a big headwind, it can certainly move higher, it is no longer the phenomenal tailwind that it was in December. 3) Relative Strength Commodities end to peak on strong momentum. Stocks tend to have multiple lower relative strength highs. With USOI, we reached a Relative Strength Index of 78.37. Stock Charts April 3, 2024 Can this go higher? Of course, it can. With geopolitical tensions still high, we can have spikes that take this to the mid-80s. But this is fairly dangerous territory to hold a Buy rating, unless you have a very strong conviction on short-term catalysts. We don't here. 4) Commodities Likely To Pull Back In A Recession We currently have the longest curve inversion, without a recession. Bloomberg/Deutsche Bank As Shared On X Maybe that indicator is broken, or maybe, just maybe, that gigantic stimulus post-COVID-19 is still being worked through. A recession is always inevitable over the long term, and we are likely to see Crude Oil move lower decisively if one comes to fruition. Verdict And One Factor For The USOI Bulls We still own energy stocks. That is a very different case than having a bullish outlook on the underlying commodity. With exploration and production plays, you are getting still 10-12% free cash flow yields with $70/barrel oil in some cases. Value investing is not dead, and we can get behind that. Speculating on the commodity here is harder. One factor, though, that may assist USOI is the massive backwardation in the futures. CME Group, April 4 2024 Readers might recall that Contango, the opposite of the case above, is what causes massive decay of commodity futures based funds. Here, we have the opposite, and the positive roll will add value to USOI. That plus the covered calls means that USOI could go down a lot less than what might happen to oil prices. We are still moving this to a \"Hold,\" and will reconsider a constructive stance if we see a better setup.  Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. 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