Shorting Oil, Hedging Tesla

[renim]

at the risk of going off-topic
the 2017 Mitsubishi ASX PHEV (Outlander Sport) is the big one, but not necessarily for Mitsubishi
http://www.autotrader.co.uk/content/mitsubishi-plans-five-new-suvs-by-2021
the particularly distinctive of that car is that its basically like a PHEV but FWD only and with a 1.1 l, 3cyl 100kW motor.

so what?

This is tech that is Chinese applicable, Mitsubishi is the largest supplier of 3rd party car motors in China, and knock-offs of their technology is even greater. Once Mitsubishi sells these cars, a horde of Chinese manufacturers can justify selling their own assimilated equivalents. Add to that, Chinese city governments decreeing a 50km electric range required for permission to use the road, and you get the picture.

can you imagine a couple of million Chinese XR-PHEV II knock-offs? It carries a lot of implications

 

[jhm]

So I'd like to follow up on a challenge I tossed out today. The question was how many EVs does it take to displace 1 Gt of CO2 emissions per year, assuming a zero emissions electricity supply. So we got estimates from 120M to 333M. And that range very well could be reasonable because of all the variability out there. So I appreciate all this input. dc_h pointed me to one source that used EIA estimates per gallon of gas. I like taking the estimate back to the fuel source because that connects with other attempts to develop oil scenarios. So I'd like to work that out.

According to the EIA, about 19.64 pounds of CO2 are released from burning 1 gallon of gas, and 22.38 pounds from diesel. In the US about 73% of fuel used in oil based vehicles is gasoline, 27% diesel. So the blended average is 20.38 pounds per gallon, or 0.389 metric tons per barrel. So 1 million barrels per day releases 0.142 Gt of CO2 per year.

Elsewhere I have estimated the need for 25 million EVs to offset 1 mbpd of oil demand. So this also reduces carbon emissions by 142 Mt per year. Thus, I derive 176 million EVs per 1 Gt/year reduction.

Under my working oil disruption scenario, we hit 50M cumulative EVs by 2024 and goes on to 200M or more by 2028. Thus, EVS knock out 1 Gt/y by 2028 assuming needed EVs between 170 to 250 million. At the low end of 120M EVs, this impact happens in 2027, and at 333M 2029. So the working scenario is pretty good regardless of whether 120 or 333 million are needed. Either way, we're in range of 2027 to 2029.

This analysis might not seem so consequential to the question hedging oil price risk, but it is highly relevant to understand the policy issues that impact both oil and EVs. How accomodating government policies to EVs may be depends in part on how much abatement potential EVs hold. What is interesting is the few countries may have zero carbon emissions electrical grids by 2030. So whatever carbon is still in the electricity supply will limit the abatement impact of EVs. This is a problem that Tesla is hitting head on with cleaning up the power supply with batteries. Still the beauty of EVS is that as carbon reduced from the electricity supply, EVs will translate this into bigger abatement impact.

So I am optimistic that EVs will enjoy increasingly favorable policy support through 2030. It get support because it delivers results. No other vehicle technology leverages renewables in the electrical supply as EVs, and there is symbiosis in using EVs to balance grids. These things will become increasing clear over time, if they are obvious enough at the present moment.

It is also important that the social and political favor that EVs enjoy will also work against the favor that the oil industry presently enjoys. So it is worth noting that my hedging scheme is based on market sentiment that correlates Tesla and oil. It is worth contemplating other factors that may actually induce negative correlation. Policy shifts can easily advantage EVs over oil or vice versa. This is negative correlation. So policy shifts have the potential to decouple the oil Tesla correlation. What happens to my hedge? Well, if policy shifts oil up and Tesla down, that would be bad for my hedged position, a double loss. However, such a policy shift seems unlikely or locally limited. So I am willing to bear that risk. But a policy shift that favors EVs over oil seems likely, if not inevitable, and would be a double win as Tesla goes up and my hedge gains as well.

Eventually, I expect oil and Tesla to decouple, and that will be a double win for my hedged position. It is hard to anticipate just when this will happen, but that's the beauty of the hedge. The hedge supports my portfolio until decoupling happens however long that may take. Then it benefits from the decoupling. Knock on wood, no black swans.

 

[jhm]

at the risk of going off-topic
the 2017 Mitsubishi ASX PHEV (Outlander Sport) is the big one, but not necessarily for Mitsubishi
http://www.autotrader.co.uk/content/mitsubishi-plans-five-new-suvs-by-2021
the particularly distinctive of that car is that its basically like a PHEV but FWD only and with a 1.1 l, 3cyl 100kW motor.

so what?

This is tech that is Chinese applicable, Mitsubishi is the largest supplier of 3rd party car motors in China, and knock-offs of their technology is even greater. Once Mitsubishi sells these cars, a horde of Chinese manufacturers can justify selling their own assimilated equivalents. Add to that, Chinese city governments decreeing a 50km electric range required for permission to use the road, and you get the picture.

can you imagine a couple of million Chinese XR-PHEV II knock-offs? It carries a lot of implications

From an oil short perspective, I love PHEVs. They really crank out a lot of oil displacement per kWh of batteries. When I talk about 25 million EVs, that is inclusive of plug-ins. The battery manufacturing capacity requirements for PHEVS is just a fraction what it is for BEV'S. So the potential to disrupt oil earlier than 2025 depends critically on PHEVS. So I'm delighted that Mitsubishi wants to bring out five models by 2021. Thanks!

 

[jhm]

Oil looks to continue its rally today. We could see $41 today. I'm looking to buy more SCO above $41.

 

[jhm]

Short-Term TSLA Price Movements - 2016

Oil bear scenario.

 

[Fallenone]

I would add a cautionary thought on shorting oil in the near and mid term (3 months - 3 years, commodity cycle is long). Long term I think oil will be just like coal today, dead, but in the near and mid term it is much more complicated. Near term you have geopolitical risks to move the oil price up and down. And since the consumption of oil is not only fuel for transportation, for the mid term tin the case of China initiating another round of infrastructure building and India figuring out how to do theirs, the demand of oil can spike and push price up significantly. China's 13th five year plan (2016-2020, it's a legacy we have from the planned economy days and serves as a governmental guidance for the next five years) has a main point of urbanization and this would increase demand for commodities, oil among them. I also heard some rumors about stimulating the economy with infrastructure constructions in the western parts of China, not verified yet. Although transportation takes up a big chunk of oil demand, in the mid term EV/PHEV just can't be significant enough and I think general economy development especially infrastructure will still dominate oil's price.

PS, TMC glitched when I wanted to post this a few minutes before. Thought I lost all but it saved some of them for me. Nice for me not have to type everything.

 

[jhm]

I would add a cautionary thought on shorting oil in the near and mid term (3 months - 3 years, commodity cycle is long). Long term I think oil will be just like coal today, dead, but in the near and mid term it is much more complicated. Near term you have geopolitical risks to move the oil price up and down. And since the consumption of oil is not only fuel for transportation, for the mid term tin the case of China initiating another round of infrastructure building and India figuring out how to do theirs, the demand of oil can spike and push price up significantly. China's 13th five year plan (2016-2020, it's a legacy we have from the planned economy days and serves as a governmental guidance for the next five years) has a main point of urbanization and this would increase demand for commodities, oil among them. I also heard some rumors about stimulating the economy with infrastructure constructions in the western parts of China, not verified yet. Although transportation takes up a big chunk of oil demand, in the mid term EV/PHEV just can't be significant enough and I think general economy development especially infrastructure will still dominate oil's price.

PS, TMC glitched when I wanted to post this a few minutes before. Thought I lost all but it saved some of them for me. Nice for me not have to type everything.

I absolutely agree. Policy risk, especially that of China, is pretty significant and can be poorly anticipated. Even so, China is by far the most aggressive mover on renewable energy and EVs, all of which they can manufacture domestically in lieu of importing fossil fuels. They cut coal imports by 30% last year and are shutting down about half of their domestic coal producers. I think this speaks to how aggressively China is willing to move. They are building out 5 million EVs by 2020, so that alone will cut oil demand by 200k bpd. This will position them to keep ramping up EVs 50% or so per year, whence they hit 25 million EVs by 2024, cutting oil demand 1 mbpd. So this new 5 year plan sets this all up. So sure they can ramp up oil consumption in the near term, but if they succeed in their plans for EVS and renewables, then 2020 the world will have a very different vision of where oil is going. That is, China alone would be positioned to take down the oil industry by 2026, no help from Tesla.

Suppose that the oil inventory by 2020 is 4 billion barrels and China alone is ready to kill 1 mbpd of demand every year starting 2026. What will be the futures price for 2026 or later? I think it would be under $35 for 2026 and under $25 for 2030. If so, then the 4 billion in storage start to flood into the market as early as 2020 driving the spot price below $25. The point here is that once China has built up a credible EVs fleet, the futures curve collapses, and this will be a disaster for the oil market long before there are enough EVs on the road to do serious damage. Just collapsing expectations will kill the market.

But my immediate goal not to be net short oil for that eventual collapse. As a Tesla shareholder, I am considerably long on oil, though I do not wish to be. So the hedge ratio basically marks out the place where I am oil neutral. Currently, my position is about 10% this hedge ratio. So I am slightly hedged, but still net long on oil. So, yeah, I'm not ready to net short oil. But I don't want to be caught seriously net long oil via Tesla in the short run.

 

[Fallenone]

I absolutely agree. Policy risk, especially that of China, is pretty significant and can be poorly anticipated. Even so, China is by far the most aggressive mover on renewable energy and EVs, all of which they can manufacture domestically in lieu of importing fossil fuels. They cut coal imports by 30% last year and are shutting down about half of their domestic coal producers. I think this speaks to how aggressively China is willing to move. They are building out 5 million EVs by 2020, so that alone will cut oil demand by 200k bpd. This will position them to keep ramping up EVs 50% or so per year, whence they hit 25 million EVs by 2024, cutting oil demand 1 mbpd. So this new 5 year plan sets this all up. So sure they can ramp up oil consumption in the near term, but if they succeed in their plans for EVS and renewables, then 2020 the world will have a very different vision of where oil is going. That is, China alone would be positioned to take down the oil industry by 2026, no help from Tesla.

Suppose that the oil inventory by 2020 is 4 billion barrels and China alone is ready to kill 1 mbpd of demand every year starting 2026. What will be the futures price for 2026 or later? I think it would be under $35 for 2026 and under $25 for 2030. If so, then the 4 billion in storage start to flood into the market as early as 2020 driving the spot price below $25. The point here is that once China has built up a credible EVs fleet, the futures curve collapses, and this will be a disaster for the oil market long before there are enough EVs on the road to do serious damage. Just collapsing expectations will kill the market.

But my immediate goal not to be net short oil for that eventual collapse. As a Tesla shareholder, I am considerably long on oil, though I do not wish to be. So the hedge ratio basically marks out the place where I am oil neutral. Currently, my position is about 10% this hedge ratio. So I am slightly hedged, but still net long on oil. So, yeah, I'm not ready to net short oil. But I don't want to be caught seriously net long oil via Tesla in the short run.

I suggest taking a grain of salt for the EV development in China. The sale number in 2015 may be fishy. Reports are surfacing of manufacturers abusing government incentives (which is really really good, about at least 30-40% of the cost per car sold) by buying the cars themselves, drive back to factory, refurbish, buy back again, refurbish. So the number actually ended up with real consumers may be several folds below the reported number. The Chinese government has already realized things like this going on and made statements of cranking this down. Recently, a BYD (largest EV/PHEV manufacturer in China) dealer hanged himself in his dealership shop. He alleged reporting BYD abusing the incentives but was met with harassment from interested parties.

And again my main point is in the mid term the development of EV is unlikely to change the price of oil if we see a demand rising from infrastructure construction. If everything else hold constant, even with EV in its infancy, it could move oil price significantly. But a burst of a few years of infrastructure construction in either China or India would easily outpace the reduced demand from alternative energy deployment and EV replacing ICE.

 

[jhm]

I suggest taking a grain of salt for the EV development in China. The sale number in 2015 may be fishy. Reports are surfacing of manufacturers abusing government incentives (which is really really good, about at least 30-40% of the cost per car sold) by buying the cars themselves, drive back to factory, refurbish, buy back again, refurbish. So the number actually ended up with real consumers may be several folds below the reported number. The Chinese government has already realized things like this going on and made statements of cranking this down. Recently, a BYD (largest EV/PHEV manufacturer in China) dealer hanged himself in his dealership shop. He alleged reporting BYD abusing the incentives but was met with harassment from interested parties.

And again my main point is in the mid term the development of EV is unlikely to change the price of oil if we see a demand rising from infrastructure construction. If everything else hold constant, even with EV in its infancy, it could move oil price significantly. But a burst of a few years of infrastructure construction in either China or India would easily outpace the reduced demand from alternative energy deployment and EV replacing ICE.

I appreciate your concern, but you are quibbling on detail regarding the long view. Ultimately it economics, not government fiat that will drive EV adoption. The scenario I set out really does not depend on who build the cars. If any set of EV and plug-in makers put 5 million vehicles on the road by 2020, the rest follows. So if Chinese auto makers want to be a part of this market, they will.

So as of 2015, there are 1.3 million registered EVs on the road. Getting to 5 million by 2020 is not a huge stretch. Moreover, it is something we can track progress on and adjust expectation along the way.

Regarding the next three years, we are in agreement. I'd certainly like to see some infrastructure projects get started in this country. Thanks.

Oh, yeah, one more thing. Suppose sufficient infrastructure projects and other incremental consumption were to drive up the price of oil for a few years. This higher cost of oil would likely boost EV adoption. So drives up the price of Tesla in the short run and the cumulative number of EVs by 2020 for the long run. So in this hedged position, the gains in TSLA make up for the losses in the hedge. So this is exactly what the hedge is supposed to do. The black swan would need to be some situation where an increase in oil prices does not lead to faster adoption of EVs. Demand from construction does not fit that bill. So I'm still scathing my head what could posibly drive oil while driving Tesla down, other idiosyncratic risks to Tesla as a single firm. The market certainly is not placing much weight on such negative correlation.

 

[Fallenone]

I appreciate your concern, but you are quibbling on detail regarding the long view. Ultimately it economics, not government fiat that will drive EV adoption. The scenario I set out really does not depend on who build the cars. If any set of EV and plug-in makers put 5 million vehicles on the road by 2020, the rest follows. So if Chinese auto makers want to be a part of this market, they will.

So as of 2015, there are 1.3 million registered EVs on the road. Getting to 5 million by 2020 is not a huge stretch. Moreover, it is something we can track progress on and adjust expectation along the way.

Regarding the next three years, we are in agreement. I'd certainly like to see some infrastructure projects get started in this country. Thanks.

We are on agreement on the long view. What I'm quibbling about is the mid term EV's impact. Even 5 million EV taking out 200k bpd of consumption in China is less than 2% of the total consumption. Therefore shorting oil on the basis of EV development for the next 3-5 years is very risky IMO.

 

[The Blue Owl]

We are on agreement on the long view. What I'm quibbling about is the mid term EV's impact. Even 5 million EV taking out 200k bpd of consumption in China is less than 2% of the total consumption. Therefore shorting oil on the basis of EV development for the next 3-5 years is very risky IMO.

Prices are set at the margin, though. A 2% permanent drop in consumption is very significant.

 

[Fallenone]

Prices are set at the margin, though. A 2% permanent drop in consumption is very significant.

That's precisely my point of murky water in the near and mid term. That 2% drop in transportation could be easily made up and exceed by 5% in infrastructure.

 

[dakh]

Does anyone here have a good handle on how these short ETF's are affected by contago? Even unleveraged ETFs that try to proxy commodity end up actually trading futures and get contago'ed out over time, so they're only good for trading. If the idea is to create a long term hedge we might have to find a different instrument.

 

[dakh]

Ok so 1.07% expense ratio which is Ok I guess but The UltraShort Funds do not seek to achieve their stated objectives over a period greater than a single day. From what I understand unless we're talking very short term (day or two) this stuff is going to bleed money over time and can't be a long term hedge.


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As you can see for example crude was at around that $53 level multiple times but over the years SCO deviated such that one could be under water 50% or more when holding SCO long term as the spot price went back to $53.

 

[jhm]

We are on agreement on the long view. What I'm quibbling about is the mid term EV's impact. Even 5 million EV taking out 200k bpd of consumption in China is less than 2% of the total consumption. Therefore shorting oil on the basis of EV development for the next 3-5 years is very risky IMO.

No, we are actually in agreement on this. Oil demand growth is expected to be about 1.2 mbpd each year for the next 5 years or so. So clearly, 0.2 mbpd is not nearly enough to impact consumption.

So the idea that EVs are displacing oil this decade is not my thesis. Actually wind and solar are having a much bigger impact on oil than EVs this decade. But this is not even my short thesis.

The reason I am shorting oil today is to hedge the risk that Tesla's share price continues to be correlated with oil. If oil drops from $40 to $30 over the coming weeks, this will likely impede if not reverse Tesla's current trajectory. So if that were to happen, as oil descends to $30, SCO will gain about 75%. This gain will give me funds to accumulate shares of Tesla. However, let's suppose oil moves up to $50 from $40 in a month. (I don't believe that is possible so long as the futures curve only goes to $52 in 2024, but let's consider it any way.) So in this run, SCO loses about 36%, but Tesla's run up is in no way impeded by a decline in oil. So my Tesla shares gain the full value that growth in the business dictates. With this gain, I rebalance the hedge position. So as a hedge, it does not matter whether oil goes up or down; I'm able to grow my Tesla position with minimal interference from oil. I have backtested daily rebalancing to confirm that this hedge does in fact reduce volatility. Currently, my hedge is at about 1.3% of my Tesla position. An optimal hedge would be at about 12.7%, my target hedge ratio. So I am currently underhedged. My Tesla position is still vulnerable to changes in the price of oil, but I will accumulate more hedge over time.

So I helps this clarifies where I am coming from. We are both in agreement that outright shorting oil is risky. But shorting oil to reduce the risk of holding Tesla hedges the correlation between the two. I know that I am not always clear about this distinction in the way I write. But technically I am not short oil. I am shorting oil only to hedge Tesla.

Ironically, many oil investors could be doing the same. Some could be shorting Tesla merely to hedge the long exposure to oil that they already have. I'm not convinced that would be a really smart hedge, but theoretically the potential exists.

Thinking more broadly both are a good thing, Tesla investors shorting oil and oil investors shorting Tesla. As hedged positions, both actually apply market force to break down the correlation between oil and Tesla. Selling one as the other rises is contrary to whatever forces cost both to rise and fall together. I have often argued that Tesla and oil should not be strongly correlated at any sort of fundamental level. My believe was that this is a false attribution in the market. So I hoped and waited for the day when oil and Tesla would decouple. What I have since realized is that I can be a part of breaking down that false correlation. If correlation is in fact a misattribution, then an arbitrage potential exists. My hedge can potentially do more than just reduce volatility, it can also generate above market returns through arbitrage. I would caution people to recognize that this arbitrage only exists as long as the market is mispricing Tesla with respect to oil. For example if there are robotraders programmed to sell Tesla everytime oil declines, this may be a dumb trade, and profit can be made trading against it. I do suspect that Tesla shorts do exploit down ticks in oil to attack Tesla's price, and such tactics interfere with the market seeking equilibrium prices for Tesla. If this suspicion is correct, there are ways to trade against it. In backtesting my hedge, I was able to produce a very high rate of return over two years time and for both years. This may be due to inefficient pricing of Tesla falsely correlating it with oil. Arbitrage opportunities often do not last long as traders figure out how to exploit them. That is part of my motivation for making the hedge public. I want traders to arb the heck out of this correlation so that it will cease to exist. Once oil and Tesla decouples, the hedge ratio in this procedure will go to zero and the hedge will be wholly unnecessary.

I hope we can have robust discussion on these points. I feel it is very important for Tesla investors not to get pushed around by oil prices. So we need smart ways to fight back, and we need solid discussion and analysis to make sure those ways are truly smart.

 

[Fallenone]

No, we are actually in agreement on this. Oil demand growth is expected to be about 1.2 mbpd each year for the next 5 years or so. So clearly, 0.2 mbpd is not nearly enough to impact consumption.

So the idea that EVs are displacing oil this decade is not my thesis. Actually wind and solar are having a much bigger impact on oil than EVs this decade. But this is not even my short thesis.

The reason I am shorting oil today is to hedge the risk that Tesla's share price continues to be correlated with oil. If oil drops from $40 to $30 over the coming weeks, this will likely impede if not reverse Tesla's current trajectory. So if that were to happen, as oil descends to $30, SCO will gain about 75%. This gain will give me funds to accumulate shares of Tesla. However, let's suppose oil moves up to $50 from $40 in a month. (I don't believe that is possible so long as the futures curve only goes to $52 in 2024, but let's consider it any way.) So in this run, SCO loses about 36%, but Tesla's run up is in no way impeded by a decline in oil. So my Tesla shares gain the full value that growth in the business dictates. With this gain, I rebalance the hedge position. So as a hedge, it does not matter whether oil goes up or down; I'm able to grow my Tesla position with minimal interference from oil. I have backtested daily rebalancing to confirm that this hedge does in fact reduce volatility. Currently, my hedge is at about 1.3% of my Tesla position. An optimal hedge would be at about 12.7%, my target hedge ratio. So I am currently underhedged. My Tesla position is still vulnerable to changes in the price of oil, but I will accumulate more hedge over time.

So I helps this clarifies where I am coming from. We are both in agreement that outright shorting oil is risky. But shorting oil to reduce the risk of holding Tesla hedges the correlation between the two. I know that I am not always clear about this distinction in the way I write. But technically I am not short oil. I am shorting oil only to hedge Tesla.

Ironically, many oil investors could be doing the same. Some could be shorting Tesla merely to hedge the long exposure to oil that they already have. I'm not convinced that would be a really smart hedge, but theoretically the potential exists.

Thinking more broadly both are a good thing, Tesla investors shorting oil and oil investors shorting Tesla. As hedged positions, both actually apply market force to break down the correlation between oil and Tesla. Selling one as the other rises is contrary to whatever forces cost both to rise and fall together. I have often argued that Tesla and oil should not be strongly correlated at any sort of fundamental level. My believe was that this is a false attribution in the market. So I hoped and waited for the day when oil and Tesla would decouple. What I have since realized is that I can be a part of breaking down that false correlation. If correlation is in fact a misattribution, then an arbitrage potential exists. My hedge can potentially do more than just reduce volatility, it can also generate above market returns through arbitrage. I would caution people to recognize that this arbitrage only exists as long as the market is mispricing Tesla with respect to oil. For example if there are robotraders programmed to sell Tesla everytime oil declines, this may be a dumb trade, and profit can be made trading against it. I do suspect that Tesla shorts do exploit down ticks in oil to attack Tesla's price, and such tactics interfere with the market seeking equilibrium prices for Tesla. If this suspicion is correct, there are ways to trade against it. In backtesting my hedge, I was able to produce a very high rate of return over two years time and for both years. This may be due to inefficient pricing of Tesla falsely correlating it with oil. Arbitrage opportunities often do not last long as traders figure out how to exploit them. That is part of my motivation for making the hedge public. I want traders to arb the heck out of this correlation so that it will cease to exist. Once oil and Tesla decouples, the hedge ratio in this procedure will go to zero and the hedge will be wholly unnecessary.

I hope we can have robust discussion on these points. I feel it is very important for Tesla investors not to get pushed around by oil prices. So we need smart ways to fight back, and we need solid discussion and analysis to make sure those ways are truly smart.

Ah yes, the original point was shorting oil as a hedge of TSLA, not just shorting oil. I'm wondering how much of the observed correlation between oil and TSLA is exclusively oil? I haven't done any stat analysis yet, but in the most part of 2015, these two didn't correlate that much did they? My theory is oil is affecting the macro (SP500 lower EPS due to the bloodbath of earnings in the energy sector thanks to plunging oil price, to maintain a constant PE, SPX needs to fall) which is also correlated to every stock out there, TSLA included. And another part is the worry of large scale default/bankruptcy in the energy sector that may lead to too much bad loans in the banking system that may lead to a systematic financial crisis. If we take these two factors out, I wonder how much impact oil has on TSLA.

Fundamentally, oil should not be positively correlate with EV development. Because it is more and more EVs on the road that will decrease oil demand, permanently, and put pressure on the price of oil. And EV would emerge victorious over ICE not because the drivers don't need to fuel them with gas, but because of the many other advantageous. But when talking with the majority of people out there (who never thought about EV seriously), the general thought on EV is an alternative to save on fuel. Well, I think we just need to wait for the others to realize what we understood now.

 

[jhm]

Does anyone here have a good handle on how these short ETF's are affected by contago? Even unleveraged ETFs that try to proxy commodity end up actually trading futures and get contago'ed out over time, so they're only good for trading. If the idea is to create a long term hedge we might have to find a different instrument.

Good question. Thanks for digging into it. I know that USO had some problems tracking WTI prices because of contango. It was rolling futures contracts which necessarily exposes one to contango. That was early in the funds life, and fund managers have gotten more sophisticated about such things. Inverse funds are a different beast, so we'll need to look into that.

For my part, being aware that ETFs do have some slippage in performance from there target indexes, I decided to calibrate and backtest directly on SCO or any other hedge instrument I might consider. Slippage happens, even if only for paying management fees and interest on leverage. I view these as simply part of the cost of the hedge. You face the same sort of issues buying an option as well. You are paying for a complex financial product. Even so, I wanted to calibrate and test the instruments directly to see how well they perform. As it turns out SCO seems to perform really well. But I do want to keep searching for other instruments that may do even better. I'd also encourage us all to try different things and share results. Collectively we can become even smarter. So I tried an inverse oil and gas industry ETF and shorting a leveraged oil ETF, UCO, and neither worked well for me. Totally different approaches may be possible using options, so someone might want to think through how that might work.

 

[jhm]

Ok so 1.07% expense ratio which is Ok I guess but The UltraShort Funds do not seek to achieve their stated objectives over a period greater than a single day. From what I understand unless we're talking very short term (day or two) this stuff is going to bleed money over time and can't be a long term hedge.


PerfCharts - StockCharts.com - Free Charts


As you can see for example crude was at around that $53 level multiple times but over the years SCO deviated such that one could be under water 50% or more when holding SCO long term as the spot price went back to $53.

That's right. That slippage is part of the cost of holding the hedge. It's like paying interest for leverage. So the question is whether you can get enough value from your hedge to make it worth the cost.

 

[jhm]

Ah yes, the original point was shorting oil as a hedge of TSLA, not just shorting oil. I'm wondering how much of the observed correlation between oil and TSLA is exclusively oil? I haven't done any stat analysis yet, but in the most part of 2015, these two didn't correlate that much did they? My theory is oil is affecting the macro (SP500 lower EPS due to the bloodbath of earnings in the energy sector thanks to plunging oil price, to maintain a constant PE, SPX needs to fall) which is also correlated to every stock out there, TSLA included. And another part is the worry of large scale default/bankruptcy in the energy sector that may lead to too much bad loans in the banking system that may lead to a systematic financial crisis. If we take these two factors out, I wonder how much impact oil has on TSLA.

Fundamentally, oil should not be positively correlate with EV development. Because it is more and more EVs on the road that will decrease oil demand, permanently, and put pressure on the price of oil. And EV would emerge victorious over ICE not because the drivers don't need to fuel them with gas, but because of the many other advantageous. But when talking with the majority of people out there (who never thought about EV seriously), the general thought on EV is an alternative to save on fuel. Well, I think we just need to wait for the others to realize what we understood now.

Exactly. This is what we need to understand well. Just how how Tesla and oil been correlated? And how might that change over time? I think long run we will transition from positive correlation to zero correlation. What does the price of film have to do with digital cameras?

I'm too tired to get into it now, but that is what we need to know.

 

[jhm]

https://app.box.com/s/46eiwfn4iodc2kqv4yzoiz7tlmm8mv5g

I thought I'd try sharing a simple spreadsheet that demonstrate monthly hedging with a fixed hedge ratio. You can play around with different hedge ratio. I got the data from Yahoo. I thought monthly would be good for illustration. Weekly or daily data would pick up more of the volatility. For example the recent decline to $150s does not show up jus looking at month end closing prices, but this is the sort of excursion where you really want to see what hedging can do. Anyway, have fun with this toy spreadsheet.