Short sellers make nearly $300 million betting against retail investors' favorite oil fund

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As smaller investors pile into the risky and troubled United States Oil Fund, hedge funds are taking the other side of that trade and making a lot of money.

As the fund, which trades under the ticker USO, plunged 75% in the last two months, those who bet against it by short selling pocketed hundreds of millions of dollars.

According to data from S3 Partners, from Feb. 27 to April 21 “short sellers went into overdrive.” The firm said that over the two-month period short sellers tripled their positions, ultimately pocketing around $286 million for a 110% return through Tuesday.

As crude oil began its historic tumble that sent prices plummeting below zero and into negative territory, bets against the USO accelerated. Over the last week, short positioning in the fund rose by 10.93%, S3 Partners’ data showed.

The USO is popular with retail investors, and recent record inflows suggest that they might mistakenly believe the fund is a proxy for the “spot,” or cash, price of oil. But this has never been the mandate for the fund, which until this week tracked the front-month, or nearest, West Texas Intermediate futures contract.

USO was the most-bought name Tuesday on Robinhood, a free stock-trading app that has attracted roughly 10 million, mostly millennial, users. By Wednesday, it was among the top 30 most-held names on Robinhood, according to the start-up.

On SoFi Invest — another trading platform used mostly by traders under 40 — USO was “by far” the highest-volume security on Tuesday and Wednesday.

Short selling is a practice used by sophisticated investors like hedge funds. It involves selling borrowed shares and then buying them back at a lower price for a profit. 

Hayman Capital Management CIO Kyle Bass has been warning investors about the danger of exchange traded funds that track oil prices and said he was short some of these funds.

“Retail has been plowing into these oil contracts thinking they’re buying spot crude oil when they’re buying the next front month. So they’re paying $22 a barrel when the spot market’s negative $38. Retail investors are going to get fleeced if they continue to fly into these oil ETFs,” he said Monday on CNBC’s “Closing Bell.”

As the fund’s losses accelerated — it’s dropped 37% in the last week — USCF, the manager of the fund, began implementing a number of changes to USO’s structure in an effort to stave off additional losses. One such change is that the fund will now hold a mixture of contracts, rather than focusing on the near-month one. USCF also executed an 8-for-1 reverse stock split in an effort to boost the stock price and stay attractive to retail investors.

A reverse stock split reduces the number of shares outstanding, thereby raising the price of the stock. This is a cosmetic change and the net effect to the return for existing shareholders will be nothing. 

USO jumped 10% on Thursday to trade at $2.77, but the fund has slid 78% this year.

While it’s likely that USO had already rolled out of the WTI contract for May delivery before it plunged into negative territory on Monday, the drop illustrated the dangers of concentrated exposure.

When asked why the fund keeps changing its structure, USCF chief marketing officer Katie Rooney told CNBC the following: “Due to extraordinary market conditions in the crude oil markets, including super contango, USO has invested in other permitted investments, as described in the prospectus.”

– CNBC’s Kate Rooney, Bob Pisani and Tom Franck contributed reporting.

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