Big leveraged bets on oil continue

With unprecedented volatility in the crude oil market, local punters are deciding this is the perfect time to go big, opting to buy risky derivatives that offer outsized exposure to the commodity.

The strategy exposes many of them the possibility of massive losses, even the loss of all principal invested.

As of Wednesday, retail investors have poured nearly 580 billion won into exchange traded notes (ETNs) linked to crude oil futures and listed in Korea, according to Korea Exchange Thursday. Of that, some 438 billion won have been invested to leverage West Texas Intermediate (WTI) futures ETNs, which can lose all their value with a 50 percent drop in the price of the underlying.

ETNs are debt instruments are designed to track underlying assets - in this case crude oil futures - and trade on the market like funds.

With demand for the instruments skyrocketing recently in Korea, ETNs have been trading at huge premiums compared to their indicative value.

The indicative value of leveraged a WTI futures ETN issued by Shinhan Investment was 60 won per share, but the instrument traded on the market at 685 won on Wednesday, 1,044 percent of its value.

“If the buyer purchases the notes at a far higher price than that of the indicative value, they will ultimately end up losing money because the oil price will never go as high as that level,” the exchange said in a release.

The ETNs can work in both ways. Some bet on higher prices, and others on lower prices with inverse ETNs. According to Korea Exchange, some 500 billion won has been put invested into five inverse instruments that track crude futures.

Issuers of inverse ETNs linked to WTI futures including Shinhan Investment and Mirae Asset Daewoo warned customers to be cautious as “jump in crude oil price could lead to 100 percent loss of their principal” through the regulatory filings on Thursday.

The Financial Supervisory Service issued its highest warning against the market regarding derivatives linked to WTI futures for the second time in its history on Thursday. Its first warning came last week for the same reason.

Korea Exchange has suspending trading in WTI futures ETNs several times since last week, but retail investors swept in as soon as the trading was resumed, resulting in another trading halt.

Trading in leveraged WTI futures ETN issued by Samsung Securities, Shinhan Investment and NH Investment & Securities was halted on April 16. When the trading resumed the next day, the price gap again exceeded 30 percent resulting in another suspension on Monday. Shinhan Investment’s ETN resumed trading Monday as the supply of the ETN was increased.

The exchange can suspend the trade of ETNs when the discrepancy between the market price and their indicative value exceeds 30 percent.

Korea Exchange said it hasn’t yet decided internally when to resume trading of the suspended derivatives.

“Retail investors are flocking to WTI-related derivatives because in the past, their price has been set between $40 and $50 per barrel and there is an expectation that it will somehow rebound to that level,” said Lim Dong-min, analyst at Kyobo Securities. “But what greenhorn investors don’t know is that the complexity of the current market situation may never lead to that level of a price rebound. Also, unlike stock trading, investors cannot make investments in a long term. When the indicative value falls by a large margin, their principal just vanishes right away.”

BY JIN EUN-SOO [jin.eunsoo@joongang.co.kr]