The Energy Sector Rally Has Some Doubters

The Energy Select Sector Index, one of the most widely followed gauges of U.S. energy equities, has been a laggard for much of this year, but finished July in strong fashion with a gain of nearly 3.1 percent. Even with that solid showing by the Energy Select Sector Index, some data points indicate some traders need convincing regarding the upside potential of the energy sector.

For instance, the Direxion Daily Energy 3X Bear Shares ERY has remained a favored destination for bearish traders over the past month even as energy stocks have shown modest signs of rebounding. The Direxion Daily Energy 3X Bear Shares attempts to deliver triple the daily inverse returns of the aforementioned Energy Select Sector Index.

Predictably, ERY is struggling as energy stocks attempt a comeback. The inverse, triple-leveraged energy ETF lost nearly 10 percent in July, reminding investors that leveraged ETFs, bullish or bearish, are best used as intraday instruments, not long-term investments.

Lingering Enthusiasm

Although the energy sector is showing incremental signs of a rebound, a scenario that could be perilous to the health of ERY, data suggest traders still like the inverse, triple-leveraged energy fund. For the 30-days ended July 28^th, ERY averaged daily inflows of over $233,000, according to Direxion data. 

Conversely, ERY's bullish counterpart, the Direxion Daily Energy 3X Bull Shares ERX, averaged daily outflows of nearly $536,000 over the same stretch. That could be a case of traders doubting the energy rally, needing some more convincing, or simply desiring to stick with a bearish point of view.

What ERY And ERX Really Do

Essential to success with leveraged sector ETFs, such as ERY and ERX, is knowing exactly what these products are intended to do. While it is clear that ERY and ERX follow a basket of energy equities, traders considering these funds should dig deeper.

The Energy Select Sector Index is a top-heavy benchmark that allocates about 38 percent of its combined weight to Exxon Mobil Corp. XOM and Chevron Corp. CVX, the two largest U.S. oil companies. In other words, betting on ERY is betting against Exxon and Chevron.

On a related note, an ETF like ERY can be an ideal short-term, emphasis on short-term, hedge on long positions in stocks such as Exxon or Chevron or the traditional energy ETFs that feature significant allocations to those oil giants.

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