This Oil ETN Pays A 21% Yield. Most Investors Don't Realize That It Is Not An ETF.

The UBS ETRACS Crude Oil Covered Call ETN (USOI) yields 21.08% by writing covered calls on United States Oil Fund (USO) positions, but this strategy limits upside gains during volatile oil markets; UBS has taken on greater credit risk after acquiring Credit Suisse, expanding its balance sheet to $1.7 trillion, almost double Switzerland’s GDP.
Oil market volatility stemming from the Iran war and the US blockade of the Strait of Hormuz creates attractive trading conditions, but once hostilities end and the strait reopens, oil prices will stabilize and covered call dividends will be reduced proportionately.
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In just a few weeks, the war in Iran has caused enormous volatility in the oil markets. With oil futures prices ranging from $50 a barrel to more than $112 this year, intraday volatility has made futures trading a very attractive proposition. The current US blockade of the Strait of Hormuz to force Iran to give up its means to create nuclear weapons is preventing any export of Iranian oil.

He UBS ETRACS Crude Oil Covered Call ETN (NASDAQ:USOI) is a publicly traded note issued by UBS. As of this writing, it offers a 21.08% yield, but it is often confused with an ETF, and that’s where the distinction can become problematic for some.

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USOI’s returns are derived from covered calls written against USO and its portfolio of futures holdings of crude oil, natural gas, gasoline and other hydrocarbon holdings.

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USOI is an ETN issued by the London branch of UBS AG. It is a note issued in April 2017 that matures in April 2037. Your portfolio contains shares of United States Oil Fund, LP (New York Stock Exchange: USE)which invests in futures contracts for crude oil, natural gas, gasoline and other hydrocarbons. USOI owns USO shares and generates its 21.08% return by writing covered calls against its USO positions. Below is an overview of the USOI:

Net assets	$325.68 million	52 week range	$45.83-$60.67
Produce	21.08%	NAV	$57.40
Daily Average Volume	146,906 shares	1 year return	32.90%
Expense ratio	0.85%	3 year return	11.67%
Payments	Monthly	5 year return	15.95%

While the 21% APY monthly payment is very attractive to income investors, the covered call strategy limits the monthly upside potential. This will result in the USOI falling behind the USO, which will benefit more fully from rising oil prices. On the contrary, once the hostilities of the Iran war have ended and the Strait of Hormuz has been reopened, the price of oil will return to trading in a narrow range. This means that volatility will be reduced and covered call dividends will decrease proportionately.

Furthermore, despite the Swiss bank’s mystique and reputation for invulnerability, UBS is in a financially precarious situation. Its acquisition of rival Credit Suisse has ballooned its balance sheet to approximately $1.7 trillion. This is almost double the entire GDP of Switzerland. Basel III compliance now requires UBS to hold even larger reserves. While it is in better financial shape than some of its current competitors in the global banking space, UBS now has a higher credit default profile than it might have had when the USOI was issued.

ETN sign against financial charts and stacked coins, illustrating exchange traded notes and financial securities, ETN finance, economic investment, market linked securities, monetary instrument — Gabriele Paoletti / Shutterstock.com

ETNs and ETFs trade on similar exchanges, but contain a number of stark differences, which can often be overlooked by casual investors.

Thanks to online trading, investments, trading and buying/selling orders for securities are just a click away. However, this has been accompanied by an avalanche of information, not all of it easily digestible for non-financial professionals. One of the obstacles that can sometimes confuse casual investors is the proliferation of exchange-traded funds (ETFs) that are now publicly traded, and the ease with which they can be confused with exchange-traded notes (ETNs).

With an ETF, the fund itself owns the underlying assets, whether they are a basket of stocks, physical commodities (such as precious metals), bonds, or even collections of derivatives. However, an ETN is itself a debt instrument issued by a bank. A summary of their differences are:

Structure: ETFs represent actual ownership shares in the ETF’s asset pool, much like a mutual fund or closed-end fund. The ETN is a collection of unsecured debt notes; Essentially, they are promissory notes from the issuing bank.

Security Risk and Resource: Since the ETF constitutes beneficial ownership of the underlying assets, there is a prorated remedy available to ETF shareholders if the ETF were to go out of business. With an ETN, this is unsecured debt, so if the issuing bank goes bankrupt, the ETN holder’s stock will likely be reduced to zero.

Liquidity: The popularity of ETFs and the fact that many of them track a specific index makes them often very liquid. ETNs, on the other hand, are much less ubiquitous and can expose investors to liquidity risks.

Taxes: Like stocks, ETFs pay taxes on dividends and capital gains each year. With ETNs, taxes are deferred until the notes are sold or until they mature.

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