UNG (Nat Gas), USO (Crude Oil), and the Term-Structure Play


In my previous post, I simulated UNG and USO all the way back to 1994 and 1985.

Both ETFs (but mostly UNG) are popular term-structure plays as of late (by shorting the ETF to capture the benefit of contango in the futures on which they’re based).

But how well would that approach have performed historically? In this post I’ll try to answer that using our expanded dataset.

[logarithmically-scaled, growth of $10,000, frictionless]

[logarithmically-scaled, growth of $10,000, frictionless]

The graphs above show the same super simple strategy applied to both UNG and USO (see end of post for a discussion of more sophisticated approaches):

Go long at today’s close when the nearest month futures contract closes above the second month (backwardation), or short when it closes below (contango). Hold the position until the opposite condition is met.

The strategy is in red and buy & hold is in grey. Results do not include transaction costs, slippage, taxes, or return on cash.

This simple strategy would have performed well over the last few years, and that’s surely why traders have been lulled in to thinking UNG and (to a lesser degree) USO are akin to VXX (i.e. that persistent contango is the primary driver of returns, which is itself not always true).

But our expanded dataset shows that, over a long enough horizon, this approach has been a dud, and will most likely continue to be a dud in the future.

Too Simple by Half

Obviously, this is an oversimplified example.

But I reach a similar conclusion when I look at other variations such as: (a) using all months (rather than just the first/second months) to measure the futures term-structure, (b) only trading very strong contango or backwardation, (c) only considering the term-structure around the 4 days each month when each ETF rolls contracts, (d) only considering longs or shorts, and (e) using moving averages to smooth the term-structure measurement.

In short, whereas other futures-based ETPs like VXX/XIV are (somewhat) tradeable simply by following the futures term-structure (read more), that’s not the case for UNG and USO.

Long-term trading success here might include taking the term-structure into consideration, but will also require timing the underlying commodity as well.

Happy Trading,

. . . . .

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2 Responses to “UNG (Nat Gas), USO (Crude Oil), and the Term-Structure Play”

  1. 1 Anton

    Michael, looking at the charts I can see sufficiently long periods of time when the strategy “trends” quite well, so one can “trade the equity curve” to take advantage of it. Most importantly, at times the strategy is negatively correlated to equities, which is perfect for portfolio diversification. I have a feeling it would also be a great addition to momentum based strategies.

    For example, the UNG play worked well in 2008-2009. Of course, it would be nice if it worked consistently, but should not we be embracing what works now? What are your thoughts?

    Would you please also let me know where the data come from. I would like to test the strategy on all commodities, if you have not already, to see if it trends often enough to trade it. Thanks!

    • 2 MarketSci

      Hello Anton – this type of commodity ETP simulation is only really possible on ETPs with clear roll methodologies (which there aren’t many of). To perform these simulations yourself, you’ll need to find accurate futures data plus the roll dates from the ETP provider. You can use the worksheet I provided for estimating VXX as an example of how to perform the calculations. Hope that helps.

      As to whether this is a viable strategy today, yes (as you alluded to) I’ve written recently about embracing what’s working now in this market, but I think this play isn’t the best. The impact of the term-structure isn’t significant enough to justify the beta risk that accompanies it, and as far as I can see, timing beta is difficult on these particular ETPs.


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