Know What’s in Your ETF and How the ETF is Calculated

One of the Fast Money guys mentioned the UltraShort Oil & Gas ProShares ETF (DUG) on yesterday’s show. He questioned how that ETF, which is the double inverse of oil & gas could be up for the day while oil was also up. A quick look at what DUG actually is gives the answer:

UltraShort Oil & Gas ProShares seeks daily investment results, before fees and expenses, that correspond to twice (200%) the inverse (opposite) of the daily performance of the Dow Jones U.S. Oil & Gas IndexSM

That “daily” part adds one complication to the picture. From the article ‘Understanding ProShares’ Long-Term Performance’ on ProShares’ site:

ProShares are designed to provide either 200%, -200% or -100% of index performance on a daily basis (before fees and expenses).

A common misconception is that ProShares should also provide 200%, -200% or -100% of index performance over longer periods, such as a week, month or year. However, ProShares’ returns may be greater than or less than what you’d expect over longer periods.

The article goes on to explain how & why this happens. But the question about how DUG could be up while the price of oil was also up is answered by looking at what comprises DUG — the Dow Jones U.S. Oil & Gas Index. That index “measures the performance of the energy sector of the U.S. equity market. Component companies include oil drilling equipment and services, coal, oil companies-major, oil companies-secondary, pipelines, liquid, solid or gaseous fossil fuel producers and service companies.” Note that the actual price of oil is not mentioned. When you look at how that index is constructed you’ll see that ExxonMobil Corp. (XOM) makes up 28%, Chevron Corp. is 11% and ConocoPhillips is 7%. So at least 46% of the index is big oil companies (major integrated oil & gas). Then the question is how does the price of oil relate to movements in those oil companies? Below I’ve plotted oil vs. the index and Exxon Mobil over the last 12 months. (For ease of charting I’m going to use the United States Oil Fund ETF (USO) as a proxy for oil. USO may have its own issues but it tracks the actual price of oil close enough to make my point.)

This shows that the price of oil has seriously outperformed the index and Exxon Mobil. Here are the actual percentage changes for each:

  • USO (oil) was up 113.2%
  • the Dow Jones U.S. Oil & Gas IndexSM was up 24.5%
  • Exxon Mobil was up 9.3%
  • DUG was down 44.1%

Well at least USO and the Oil & Gas Index went in the same direction over the last 12 months. But on any given day, like today, they could trade opposite each other. And that means that DUG, on any given day, could trade with oil instead of opposite oil. I think many people would assume that if oil was down 5% DUG would be up 10%. That’s clearly not a good assumption to make I’m seeing a lot of people talking about buying DUG to profit from a drop in oil prices. Given the performance data above I think they’d be better off shorting USO. (That is, if they can find shares of it to borrow — I’ve had problems with that in the past.) Puts on USO may do the trick too.

Hopefully those who are trading DUG know that they’re not playing the price of oil directly and won’t be surprised on days like today when DUG and oil trade in the same direction. You’ve always got to know what comprises any ETF. I know that Google directs a lot of people to my list of inverse ETFs who are specifically searching for a way to short oil. Hopefully they do more research than just look at the name of the ETF and really find out what they’re getting.


  1. Posted by upsidetrader on May 24, 2008 at 7:59 am

    Hey Mike,
    Great post. I have been trying to shed light on this for a while and have blogged about the possible reasons for the odd behavior. You nailed it and I linked it over at my joint.Thanks, many readers were very confused.


  2. Posted by Dr. Duru on May 25, 2008 at 12:00 pm

    Another thing to add is that XOM, COP, and CVX also have significant refining businesses. These businesses are barely making any money as oil goes sky high because they can’t raise gasoline prices fast enough.

  3. Posted by Walonline on May 26, 2008 at 11:57 am

    Great article, Mike.

    Really interesting that an ETF designed to short the oil and gas markets is long on such a large portfolio of major producers. Could this be a frontier for further regulation, or simply another case showing the importance of really knowing your investments? I believe the later.

  4. Posted by Michael on May 26, 2008 at 12:26 pm


    It’s not long those producers, it’s short. It’s short the index which is long the oil & gas companies. The key thing I was trying to get across is that the movements of those companies can be independent of the actual price of oil in the short term.

  5. Posted by TraderMD on May 26, 2008 at 6:45 pm

    In short, the DUG is the inverse of the DIG.

    The DIG is basically an ultra version of the OIH.

    Hopefully that wasn’t too confusing.

  6. Posted by Will on May 26, 2008 at 8:57 pm

    Hi Mike! Still follow ya regularly, buddy. Thanks for yet another insightful post which gave so many of us an “aha!” moment.

  7. Posted by beanieville on May 26, 2008 at 9:36 pm

    Lots of unsettled spirits at the USO july 100 puts on thursday.

    We joined them.

    Death to oil.

  8. Posted by joshm on May 27, 2008 at 12:49 am
  9. Posted by Sia on May 27, 2008 at 3:31 am

    Yessss. I actually emailed them on friday saying they should be ashamed for not even knowing what the ETF really is. Also, a while ago they kept saying OIH is a proxy for the refiners, which in reality is a better proxy for oil services and drillers. A lot of people don’t even take the time to figure out what stocks are behind an etf, its a shame.

  10. Posted by Michael on May 27, 2008 at 7:24 am

    DCR might be good if it wasn’t about to disappear:

    From an article at Bespoke :

    In early April, we pointed out the DCR/UCR trade to Bespoke readers, noting that if oil closed above $111 for three consecutive days, the two notes would hit termination at the end of the quarter at wherever their NAVs were trading. UCR is the “oil up” note and its NAV is calculated by dividing the price of oil by three. DCR is the “oil down” note and it is calculated by subtracting UCR’s NAV from 40.

    Once oil closed above $111 for three days in a row (seems so long ago), the termination triggered, so at the end of this quarter, the notes will be distributed to holders at their NAVs. But now that oil is trading above $120, DCR has no NAV [40-(120/3)=0]. Surprisingly, DCR’s price is still trading at a premium to its NAV, and if oil is above $120 at the end of the quarter, owners will lose all of their money, effectively making it an option play on oil’s decline at this point. UCR, on the other hand, will distribute $40 per share if oil is above $120, even though its price is trading at $37.26.

    Also see this article for more on DCR

  11. Posted by hello all on May 27, 2008 at 12:57 pm

    or if you’re bearish the energy complex, you can short coal/KOL/MEE, etc. as a proxy…..or
    solar plays (but getting hard to find shares).

    Or the tanker stocks.

    Or go long DEE (big spreads and hope that DB stays solvent, ha).

  12. Posted by Investor Hub on May 28, 2008 at 1:34 pm

    Hey, Thanks for this informative post. From a long time I was wondering about this topic. Its good some one has covered it in this depth.