NRGD: Oil ETN with -3x leverage, take advantage of tensions in Ukraine

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Thesis

The BMO MicroSectors US Big Oil Index -3X Inverse Leveraged ETN (NRGD) is an exchange-traded note that aims to give an investor three times the daily inverse performance of the Solactive MicroSectors US Big Oil Index. The index is made up of 10 major North American oil and gas companies. The return is based on changes in the level of the index on a compounded daily basis.

The following Ukrainian tensions paved the way for increasing price volatility in energy, with NRGD presenting itself as a viable very short-term leveraged trading tool. The fund is not a buy-and-hold vehicle, having lost more than 90% over the past year due to rising oil prices. A sophisticated investor can nevertheless use the ETN as a very short-term trading tool to take advantage of overstretched oil markets and increased volatility.

On days when the Energy Select Sector SPDR (XLE) fund is down -3%, the NRGD fund may be up +9%. We just saw this type of performance on Friday January 21, when NRGD was up 8.2% for the day. We believe the oil market has entered a cyclical phase running of the bulls and we are going to see oil at $100 WTI very soon, but nothing goes straight up.

The NRGD is a good tool to take advantage of temporarily overextended oil markets and negotiate the situation in Ukraine, which is bound to have significant volatility spillovers. Please note that the NRGD is based on a basket of stocks that may go down on a risk-free trading day even if oil prices as measured by Brent/WTI are up. Thus, NRGD is well set up to incorporate equity risk as well as the direction of oil prices.

European market players can rely on CFDs to make leveraged bets on very short timeframes while North American investors can turn to leveraged tools like NRGD to accomplish the same feat. A retail investor who wants to take a leveraged bet on the fall of major North American oil and gas companies can use NRGD for very short periods of time (1-3 days, we think is best).

The difference between an ETF and an ETN

There are distinct differences between an Exchange Traded Fund and an Exchange Traded Note that an investor should be aware of. An exchange-traded note is actually an unsecured bond issued by a bank in this case (Bank of Montreal) that offers an investor the specified yield. An ETN inherently has an increased risk compared to an ETF because it is not far from bankruptcy. An investor buying NRGD would be fully exposed to the credit risk posed by Bank of Montreal. In the unlikely event that Bank of Montreal is taken over by a regulator or experiences a bankruptcy event, an investor in NRGD would become an estate creditor, but would actually lose a substantial amount of non-oil value. and the underlying gas. exposure.

The most famous case of bank failure is that of Lehman, and indeed there were a number of Lehman-sponsored ETNs that served a cautionary tale for ETN investors. Always make sure you understand the difference between an ETN and an ETF and are comfortable with the ultimate sponsor.

Also, because NRGD is actually a bond issued by Bank of Montreal, it has a maturity date, which is March 25, 2039. So another risk to consider here is that if you hold this vehicle at a loss hoping it “comes back”, please note that on the above date the bond matures, which means you will get back the principal at the market price at that time with no further exposure to the portfolio under -lying. Thus, you will crystallize your loss / gain permanently.

The best way to think of an ETN is that it is a true funding vehicle for the underlying bank (Bank of Montreal) in this case, and the institution embeds a certain yield profile into its bond so that it can i) finance itself, ii) earn some vehicle management fees.

Assets

The portfolio is currently made up of the largest North American oil and gas majors, with both integrated operations and more specialized players:

NRGD holdings

Index Securities (Fund Fact Sheet)

The index is equally weighted, with each underlying company making up 10% of the portfolio. This methodology avoids giving more weight to the best performing stocks in the index and is a more balanced representation of the performance of major oil and gas companies.

Performance

The fund has lost more than 90% in the past year as the prices of major oil and gas companies have risen:

NRGD performance

NRGD (Seeking Alpha) performance

As the structural bull market in oil continues, our longer-term expectation is that the Energy Select Sector SPDR Fund (XLE) will continue to rally while NRGD will continue to lose value. The ETN is not a buy and hold vehicle. Expect NRGD to lose much more value in 2022 from then on. NRGD is a short-term trading tool for taking advantage of overbought and overbought oil markets.

The fund is very volatile with average daily movements of +/- 5% in 2022:

NRGD Daily Change

% daily change (author)

We can see that the fund has a general bearish performance in 2022 so far given the disproportionate presence of down days versus up days. We expect NRGD to decline in value in 2022 as we believe oil prices will recover. NRGD should only be used for days like Jan 21 where it is up more than +8% for the day.

Conclusion

NRGD is an inverse leveraged oil ETN offering a -3x return of the Solactive MicroSectors US Big Oil Index compounded daily. The fund is not a buy and hold tool and is poorly positioned for what we believe to be a structural bull market in oil prices. However, nothing is progressing in a straight line and oil markets have been overloaded several times over the past six months. The Ukrainian tensions are adding more volatility to this sector, with news from the region causing outsized movements in the index’s constituents. A retail investor who wants to take a leveraged bet on the fall of major North American oil and gas companies can use NRGD for very short periods of time (1-3 days, we think is best).

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