How To Play Oil's Short-Lived Rally

There has been plenty of chatter about an alleged oil rebound in recent weeks. If the United States Oil Fund USO, which tracks front-month West Texas Intermediate crude futures, being up half a percent over the past month qualifies as a legitimate rebound, so be it.

Oil equities have been vastly superior over that period. For instance, the usually volatile SPDR S&P Oil & Gas Exploration & Production ETF XOP is up 10.3 percent over the past 30 days and that is even with the burden of an almost 5.4 percent decline over the past week. Still, there are reasons to be cautious with the oil patch, both futures- and equity-based exchange traded funds.

There is political wrangling regarding the US potentially becoming an oil exporter and headlines about Saudi Arabia moving to crush the U.S. shale boom. The Direxion Daily S&P Oil & Gas Exp. & Prod. Bear 3X Shares DRIP, which aims to deliver triple the daily inverse returns of XOP's underlying index, is apt to enjoy any retrenchment by energy equities.

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"Iran plans to raise oil production by 500,000 barrels a day in the first week after sanctions are lifted, according to the oil ministry news agency Shaha. On Sunday, the United States approved conditional sanctions waivers for Iran, OPEC's second largest oil producer. Iran targets crude production of 4.7 million barrels a day by March 2021 and plans to produce 1 million barrels a day of crude by the same date. Just what the already saturated oil market needs – more oil," said Direxion in a recent note.

As of October 21, DRIP was the second-worst performer among Direxion's triple-leveraged ETFs on a month-to-date basis, while the ETF's bullish counterpart, the Direxion Daily S&P Oil & Gas Exp. & Prod. Bull 3X Shares GUSH, was the second-best performer among the issuer's triple-leveraged bullish products.

Interestingly, Direxion data indicate traders have recently favored DRIP to GUSH as over the past 30 days, the former has seen positive creation activity while the latter has averaged outflows on a day-to-day basis. Muddling the bullish thesis for any long oil ETF, futures and equity funds alike, is OPEC's refusal to pare production to support prices. Rather, the cartel could flood market with excess supply just to burn rival producers.

"In fact, OPEC underwent a strategy to regain market share, keeping supply levels constant, even as prices plummeted over the past 12 months, in the belief that the price slump would squeeze out U.S. competitors who have a higher cost structure. That strategy may be showing signs of success. Since oil prices began to drop in fall 2014, U.S oil & gas producers have laid off over 150,000 workers, and cutback drilling substantially," adds Direxion.