ProShares Ultra Oil & Gas ETF – Time To Take Some Profits (NYSEARCA:DIG)

Thesis

ProShares Ultra Oil & Gas (DIG) seeks daily investment results that are 2x the daily performance of the Dow Jones U.S. Oil & Gas Index. The ETF achieves a leveraged return profile via swaps. The Dow Jones U.S. Oil & Gas Index is composed of 36 companies from the medium and large cap category and aims to replicate the performance of a subset of companies in the North American oil and gas sector. DIG is a leveraged ETF hence not appropriate for a pure buy-and-hold investor. The fund lost more than 90% of its value during the COVID downturn and has a very high volatility which is reflected in a 3-year standard deviation above 83%. DIG is to be used as a trading tool for distinct periods of time and is best utilized with a maximum 3-month time-frame in mind. 2021 saw a very volatile performance with the fund being up +50% in the beginning of the year only to give that all up by the summer. Given its performance year-to-date (up more than 46%) there will be an unavoidable dip on the march higher to $100 WTI oil. Traders would do well to take some profits here and wait for a lower entry point. The ETF also has an option chain, meaning that retail investors can trim outright long positions but add net longs via cash covered puts. This strategy takes advantage of the ETF’s very high implied volatility and generates a high yield or lower cost entry point into the vehicle.

Holdings

In order to gain a leveraged exposure to the Index DIG utilizes swap agreements. The derivatives track the performance of the underlying index but there is a financing cost associated with them that impacts the ETF at the end of the day. By virtue of entering into swap agreements with banking counterparties the ETF is running some counterparty risk if the swaps are not cleared by CCPs (central counterparty clearing houses). This is an additional, albeit small, risk to consider when looking at a leveraged ETF. A non leveraged vehicle will just hold the underlying financial instruments thus not running this smaller derivative counterparty risk.

The Dow Jones U.S. Oil & Gas Index seeks to measure the performance of a subset of corporates in the oil and gas sector. The respective companies typically are engaged in exploration and production, integrated oil and gas activities and providers of oil equipment and services. The current index top composition is as follows:

The total number of companies in the index is 36 and the current composition is overweight the Oil, Gas & Consumable Fuels sector:

The index is skewed towards mid and large cap companies:

Please note that the current fundamental set-up for the index is already skewed towards richer pricing with a Price/Book Ratio of 1.94.

Performance

DIG is up more than 130% on a 1-year measurement window but with significant volatility:

We can see that the ETF had a +50% performance in the beginning of 2021, only to give it up almost entirely by the summer. Leverage works both ways and while upswings are magnified, so are downturns.

During the COVID downturn DIG lost almost all of its value:

The fund was down -90% during the peak of the COVID downturn. Like with any leveraged product DIG is not a buy and hold vehicle but a trading tool for shorter time frames.

DIG is up more than 46% year-to-date:

As oil has rallied towards the $100 mark and there is increased chatter that reaching that milestone is a done deal, DIG has rallied significantly. Nothing goes up in a straight line though, and we expect a modest downturn to move the technicals back to neutral. DIG is a trading vehicle given its leverage and it should be treated as such. The significant outperformance this year should be monetized by trimming positions and waiting for a dip.

Option Chain

A lesser known fact is that DIG has an option chain:

If you still like DIG but want to trim positions as well then you can sell half your shares and write cash covered puts. If DIG has a breather and dips in the short term but continues to rally afterwards into June a cash covered put is a good way to monetize that view and take advantage of the very high implied volatility in the option chain.

For example a June 17, 2022 cash covered put trading at the money has an implied volatility exceeding 60% and pays a premium of ~$16 giving you an ultimate entry point of below $100 into the vehicle.

Conclusion

DIG is a leveraged ETF that helps an investor gain access to the Dow Jones U.S. Oil & Gas Index. The fund is not a buy-and-hold vehicle suitable for retail investors but a trading tool for short time frames. Up already 46% year-to-date DIG is due for a dip, so it would be useful to take some profits off the table. An option chain is also available for the ETF, giving a savvy investor a synthetic way to gain access to the fund via cash covered puts which ensure a lower entry point into the fund.