The fall in oil prices continued on Tuesday, the June WTI contract was offered a short-term support at around $ 10.60, front-month Brent contract is trading below $ 20 per barrel. With such scary nosediving moves the question arises about the true cause of the wave of liquidation which started on Monday. Settlement of June WTI contract will take place on May 19 and, in general terms, the core underlying problem is still an unresolved issue of WTI physical delivery. However, the fall of oil price below 0 due to a lack of liquidity drew market attention to the vulnerability of oil ETFs, which need normal liquidity to transfer positions to the next contract month (which is called rollover).
Of greatest interest are the positions of USO, the largest oil ETF in the United States. It came to the attention of traders after the April 20 carnage due to the fact that a fairly common trading strategy for commodity ETFs – holding front-month futures and sequentially rolling them over to the next month, began to have sharply increased risks. Although the USO rolled over into the June contracts some time before the collapse of May WTI, same delivery issues for June contract were creating huge risks for investment position of the fund in terms of opportunity for safe roll-over. On April 23, the fund said that it is going to change its holdings from June contracts to the following composition:
To change the composition of its investments, the USO has to entirely sell its June contracts and buy the ones indicated on the chart. But what is most remarkable, in the same statement, the USO indicated exact timeline of alteration of its investment portfolio (from April 27 to 29, by 33.3% every day).
In simple words, the largest oil ETF in the US has clearly indicated what it will sell and what to buy. Well, how could you not front-run them here? Basically, it is probably the biggest and most evident market inefficiency for decade.
And the oil sell-off which began on April 27 is most likely a result of the fact, that a major participant, in this case the USO, announced in advance that it would sell all the June contracts to which it had previously been rolled over. The dovish pressure from other market participants has created a large speculative wave, which is only gaining momentum, as another 66.6% of the USO contracts in June will be sold today and tomorrow.
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