The contango conditions in Crude Oil futures that have been a real hindrance to commodity ETF’s (USO for example) continued to widen in August according to a recent Bloomberg article. Contango is little more than a fancy word for explaining a futures contract curve where the further out contract months are more expensive than the front month contract months.  Oil is currently “in contango” with he October crude oil futures priced at 75.20 while the further out December contract is trading over $3.00 higher at 78.45.

The reason why this scenario hurts commodity ETF investors is that the fund will eventually be forced to roll from the less expensive October contract to the more expensive November contract (trading at 77.00), and eventually into even more expensive December contract that is almost $3.00 higher.  Each time the fund rolls to a higher price, ETF investors PAY the spread and lose money in relation to the cash price of oil.  Read more about the problems with commodity ETFs in our past newsletter; Are Commodity ETFS Bad for Managed Futures?

One managed futures program that attempts to take advantage of contango conditions is the Emil Van Essen Spread Program (available to QEP investors only). Mr. Van Essen has developed a calendar spread trading strategy that looks to sell the lower priced front month contract, while simultaneously buying the more expensive further out contract. Using the oil contango example above, if Mr. Van Essen were to sell the October crude oil and Buy December crude oil he could have had a profitable trade last month as the upward price of the December contract outpaced the upward price of the October contract.

In reality, Mr. Van Essen placed two slightly different crude oil spreads in August. First, the program went short September crude and long October crude. This trade was closed out for gross profit (before fees) of approximately $169 per contract. Next, the program also put a calendar spread on where the program sold December 2011 crude oil, while buying December 2012 crude oil. This trade had a gross profit of $1830.00 per contract. [past performance is not necessarily indicative of future results] It is important to note that the short leg of this spread was the driver of these returns as the downward pace of December 2011 crude outpaced the December 2012 contract.

The ETFs have tried to adapt, spreading their rolls across several days and even trading further out months – but until they completely figure out the problem, traders will continue to try and take advantage of the knowledge that these funds are long only, and have to eventually roll to another contract.