Excessively bearish oil traders were caught with their pants down Friday as a rebound in energy prices triggered a round of short covering, bolstering oil-related exchange traded funds.
The United States Oil Fund (NYSEArca: USO), which tracks West Texas Intermediate oil, declined 2.8%, surged 7.0% Friday while the United States Brent Oil Fund (NYSEArca: BNO) jumped 6.1%.
WTI crude oil futures were up 6.4% to $47.4 per barrel and Brent crude oil was up 5.9% to $52.0 per barrel Friday. Light, sweet crude gained as much as 8.3% Friday, the largest one-day percentage increase since June 2012.
Energy futures strengthened Friday after data revealed a steep drop in number of U.S. rigs drilling for the oil industry, and gains were further fueled by bearish traders rushing to cover their shorts, reports Christian Berthelsen for the Wall Street Journal.
After months of selling, bearish traders may have gotten complacent, betting on further declines in the oil market as a given. Consequently, any sudden change in the supply side could trigger quick rebounds, especially if there is a short squeeze.
A short position is a sale on a borrowed security. The investor needs to eventually return the borrowed stock by purchasing it back from the open market. If the price falls, the investor buys it back for less than he or she sold it for and pockets the profit.
A short squeeze occurs when investors with heavy short positions are forced to cover, or buy back, their shorts in the event of positive reports that result in a share appreciation – short sellers are essentially being squeezed out of their short positions, typically at a loss. Consequently, the additional buying momentum from short sellers covering their options contracts help bolster prices even further.
Triggering the sudden jump in oil prices, oil-field services company baker Hughes revealed that the number of domestic drilling rigs declined 7% for the week to 1,223, the lowest level in three years, which would affect the future supply outlook.
“This is another sign that the drop in energy prices is going to impact future production of oil,” Phil Flynn , an account executive at Price Futures Group, said in the WSJ article. “People who have been short are starting to have second thoughts about staying short at this level.”
Additionally, geared ETFs that take leveraged position on oil futures also jumped on the bullish turn. The ProShares Ultra Bloomberg Crude Oil (NYSEArca: UCO), which takes the two times or 200% daily performance of WTI crude oil, increased 14.4% Friday while the VelocityShares 3x Long Crude ETN (NYSEArca: UWTI), which tracks three times or 300% the daily performance of WTI crude, gained 21.3%.
United States Oil Fund
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Max Chen contributed to this article.