The Best Way to Trade Summer's Worst ETFs

Energy funds OIH and TAN tend to fare the worst over the warmer months

by Bernie Schaeffer

Published on Apr 29, 2019 at 8:34 AM
Updated on Apr 29, 2019 at 8:34 AM

The following is a reprint of the market commentary from the May 2019 edition of The Option Advisor, published on April 26. For more information, or to subscribe to The Option Advisor -- featuring 10 new option trades each month -- visit our online store.

The month of April is rapidly coming to an end, and that means it's time for one of the stock market's most self-indulgent annual traditions. About a third of the way through the second calendar quarter of each year, technicians, fundamental analysts, quants, and sentimenticians set aside their differences to unite in preparing their respective arguments in favor of and opposed to one truly arbitrary rhetorical question: Should you, in fact, "sell in May and go away"?

(The short answer, for now and for all eternity, is "no." In the month of May, as in all other months of the year, you should endeavor to take a "scalpel" approach to your trading rather than the "axe" method -- meaning that while there may be a few holdings you choose to divest, on their own merits, as the weather warms up, there may be other opportunities worth entering anew during this same time period.)

While seasonality is generally best viewed as a starting point rather than a tradable indicator unto itself, most Americans are familiar with the reasonably reliable pattern of gas prices peaking into Memorial Day weekend, and then softening into the second half of the year. It's a trend that's hinted at by the performance over the past 10 years of the Invesco DB Oil Fund (NYSEARCA:DBO) during the roughly three-month stretch from Memorial Day through Labor Day, as outlined in the first table below. Crude-price tracker DBO is the second-worst performing sector exchange-traded fund (ETF) over this summertime period, with only 40% positive returns and averaging a decline of 3.18%.

Drilling down on a month-by-month basis over the past decade, DBO averages a negative return in each of the last eight months of the year -- notably, a streak that includes the May-through-September gauntlet. What's more, May and September have the lowest percentage of positive returns among all months, at 40%, while July and May tend to hit DBO with its third and fourth steepest average monthly declines of the year.

Meanwhile, April is generally the month where DBO racks up its highest percentage of positive returns, at 70%, as well as its biggest average monthly gain (3.73%). As of this writing, the ETF has advanced more than 6% on a month-to-date basis, putting DBO well on pace for a 2019 repeat of this bullish April pattern.

Given the rather predictable weakness in energy prices that coincides with the beginning of summer, it's not too surprising that the VanEck Vectors Oil Services ETF (NYSEARCA:OIH) clocks in as the third-worst sector ETF of the hotter months. OIH "outperforms" DBO with 42.9% positive returns over the seven years since its reintroduction to the market, but averages a wider 4.06% loss from Memorial Day through Labor Day.

Even a bit worse than both OIH and DBO, though, is an ETF name from the entirely opposite spectrum of the energy sector: the Invesco Solar ETF (NYSEARCA:TAN), which combines DBO's 40% positive returns with an average summertime decline that, at 4.02%, easily rivals that of OIH. So is the "surest" bearish sector seasonality bet to short the sun for the summer, or is tried-and-true oil still the short trade to beat?

worst sector etfs may-sept 10 yrs

OIH returns over the summer aren't quite as abysmal as DBO, as the ETF -- rather than simply tracking commodity prices -- includes companies with a mix of upstream and downstream operations, such as Schlumberger (SLB), Halliburton (HAL), and Transocean (RIG). While DBO averages a negative return in every month from May through January, OIH averages gains during June, September, and January.

That said, OIH swallows its second-worst average monthly return of the year in May, with a mean loss of 4.30% -- and the median decline of 6.15% is the worst of the year. That's thanks to a relatively low percentage of positive returns in May, at only 43%, while OIH's average negative return for the month is a steep 8.28%, compared to a slim average positive return of only 1.01%. However, the fund's performance is fairly evenhanded in June and July, before skewing slightly bearish again in August.

Overall, with its average return for Memorial Day through Labor Day weighing in at a loss of 4.06%, the month-by-month breakdown paints the picture of a fast drop followed by a slow, steady drip lower over the following months.

But ahead of this expected seasonal slump, it's worth pointing out that investors already seem to have had a bearish change of heart on the sector (even amid this week's news that the Trump administration will discontinue Iran oil waivers). After net inflows totaling $776.48 million during calendar years 2017 and 2018, per etf.com, OIH has registered net outflows of $504.68 million in just under four full months of 2019. And perhaps most importantly, from a contrarian perspective, those outflows have occurred against the backdrop of OIH gaining about 25% year-to-date, while reclaiming a foothold atop its 50-day and 80-day moving averages.

oih average returns by month since inception

As for TAN, the fund's top holdings are primarily divided between the U.S. and China, with some Europe exposure also in the mix. Names like First Solar (FSLR), SolarEdge (SEDG), and SunPower (SPWR) are among the key components that have helped steer TAN to what is, as of this writing, a roughly 10% month-to-date advance for April.

That's right in line with TAN's average positive return of 9.67% for April -- which then precedes a seven-month losing streak from May right into November, before the ETF flips narrowly positive in December. Within that historically weak stretch, June has the lowest percentage of positive returns, at only 27%. During both June and August, meanwhile, TAN averages a monthly loss in excess of 2%.

On the charts, TAN just peaked shy of the $26 level -- which roughly coincides with its March highs, and sets up a potential repeat of the 2018 action, where the shares topped out around $27 in both the first and second quarter before sliding lower into the second half of the year.

However, it may be after Labor Day where TAN suffers its heaviest losses. The ETF averages a drop of 3.27% in September, followed by mean declines of 5.21% in October and 4.45% in December. Plus, its average negative return is in the double digits for all of the last four months of the year. Based on this breakdown, the worst for TAN may not come until around the mid-to-late fourth quarter.

tan average returns by month since inception

All things considered, the best way to play a possible seasonal slump in energy right now might be a bearish put position on DBO or OIH coupled with a bullish call trade on an outperforming (yet underloved) sector component stock, in a "paired trade" setup. Using options limits your capital at risk compared to stock trading, while pairing two diametrically opposed directional plays within the same sector provides a built-in "hedge" against macro headwinds while simultaneously creating multiple possible paths to profit.


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