GUSH – Take Advantage Of The Dip Via Options (NYSEARCA:GUSH)

Thesis

The Direxion Daily S&P Oil & Gas Exploration & Production Bull 2X Shares (NYSEARCA:GUSH) seeks daily investment results of 200% of the performance of the S&P Oil & Gas Exploration & Production Select Industry Index. The S&P Oil & Gas Exploration & Production Select Industry Index (SPSIOPTR) is provided by Standard & Poor’s Index Provider and includes domestic companies from the oil and gas exploration and production sub-industry.

GUSH is a leveraged product and like any other tool from this suite it should be used as a short-term trading instrument by sophisticated investors rather than a buy-and-hold security. The ETF has tremendous volatility and very deep pull-backs. Although the fund is up over 90% year to date, it has experienced pull-backs as deep as -50%, the most recent one being in April. A conservative approach to buying GUSH is by using cash covered puts which take advantage of the very high implied volatility embedded in the GUSH option chain. A high implied volatility results in rich option premiums which can be monetized via the selling options strategy.

We feel the current dip in GUSH is temporary and will reverse in the next few weeks, but would rather undertake a more conservative strategy via cash covered puts in Buying GUSH.

Performance

The fund is up more than +90% on a year-to-date basis:

However, just like any leveraged product, the fund experienced very deep draw-downs during this uptrend. The latest one has just ended and it amounted to a -50% pullback when looking at the vehicle from a total return perspective.

A leveraged product is to be traded with short time horizons in mind, and more importantly with tight profit targets that once hit should trigger the unwinding of the trade. For example, earlier in the year, as we can see from the graph, GUSH was up +125% for the year, only to lose -50% in one week. GUSH is not a buy-and-hold vehicle but a trading tool for shorter time frames.

The same story can be observed in mid-March when the fund experienced a -25% drawdown as part of a general uptrend. We are now again at an inflection point where we think the current dip should be bought, but we are proposing a more conservative strategy that utilizes options.

Holdings

The fund invests in a portfolio of E&P companies. Compared to another offering from Direxion, namely ERX, we can see that GUSH focuses on smaller Exploration & Production players rather than the large Oil & Gas majors characteristic to ERX:

A quick look at the market capitalization of the top three positions in each index gives us a flavor for the difference in market cap and type of companies composing the portfolios:

What Is The Trade?

What we are proposing in order to take advantage of higher oil prices and the temporary dip in GUSH is a synthetic way of buying the name:

Here a sophisticated investor would sell a cash covered put strategy in order to generate an annualized yield of over 100%. The proposed trade involves selling 3 put contracts on GUSH, with a maturity date of June 17, 2022 which is only 49 days out. By selling the said contracts the maximum exposure the investor can have to the name is $51,000. Given the very high implied volatility exposed by the option chain, the current premium on the bid side for the described trade is 24.6, which translates into a cash amount of $7,380 for the 3 contracts. When annualizing the $7,380 as a percentage of the maximum cash out the door, an investor would actually receive an annual yield in excess of 100% on the trade.

What are the possible trade outcomes:

1) On June 17, 2022 the price for GUSH is above $170

• the sold puts expire worthless
• the investor realizes a gain of $7,380
• the gain represents 14% of the theoretical cash out the door, or when annualized a yield in excess of 100%

2) On June 17, 2022 the price for GUSH is below $170

• the sold puts are triggered by the buyers
• when factoring in the premium for the options the investor ends up buying GUSH at a price of $145.4, which is 14% lower than the current spot level

The proposed trade is a conservative way to buy GUSH, although the upside is limited to the received premium. However given the extraordinary implied volatility in the option chain (keep in mind that the 1-mon vol for the S&P 500 is around 25%, while the GUSH 1-month option has an implied vol above 90%) an investor could realize returns in excess of 100% by just rolling the proposed trade as part of an uptrend.

Conclusion

GUSH is a leveraged ETF that gives a sophisticated investor 2x the daily return of the S&P Oil & Gas Exploration & Production Select Industry Index. Like any other leveraged product GUSH is extremely volatile and should only be used by sophisticated investors as a trading tool with tight profit targets and stop-losses. Up more than 90% on a year-to-date basis GUSH has experienced very significant pull-backs, with the latest one being -50%. We feel that the uptrend in GUSH will resume after the current dip, but a more conservative alternative to just buying the ETF outright is a cash covered put strategy. Selling 3 contracts of the June 17, 2022 GUSH $170 (ATM) puts can generate an annualized yield of over 100% if the price upon expiry is above the strike level.