I usually try to write original posts, but now and again there’ll be posts from other sites that I’d like to bring to your attention, especially for the newer traders.  Ft.com’s Alphaville blog posted this great “look under the hood” of the UNG Natural Gas ETF and the crisis this ETF is experiencing.  ETFs are now the preferred trading/investing vehicles for both professionals and individuals, giving literally everyone the opportunity to be be involved with formerly exotic instruments such as long treasuries (TLT), short treasuries (TBT), gold (GLD), Euro Currency ETN (FXE), the list goes on.

However, ETFs (exchange traded funds) and ETNs (exchange traded notes) are very very young financial instruments whose trading characteristics and life-span is still in unproven.  One only needs to look to the implosion of the 3x Direxion leveraged ETFs FAZ & FAS financials fad, decaying nearly exponentially like short-term options just months after these came public.  Or consider the difficulty of trading crude oil using ETFs like the popular United States Oil Fund (USO).  Due to the inherent nature of the oil futures market instruments, USO’s fund managers have much difficulty using these futures instruments to create synthetic tracking of oil prices. (@tradefast has a great post on divergence between various oil-tracking ETF’s)

If you’re trading or investing these or any ETFs, please due your due diligence and make sure you understand all aspects of the instrument you’re trading and not just what the ETF tracks or which stocks or commodities a ETF is involved in.

FT.com Alphaville: The Problem with commodity ETFs
Posted by Izabella Kaminska on Jun 11 17:31.

The day ahead of the United States Natural Gas (UNG) ETF’s futures roll from the July to August contract, Olivier Jakob of Petromatrix — who has inadvertently become a bit of a lone crusader in the mission to expose the influence of exchange traded funds on commodity markets — presents an impressive summary of the story so far.

His primary observation:

ETFs [based]on Commodity Futures have a basic design flaw in that they are open-ended fund that invest in assets (Futures) that are close-ended (either due to CFTC regulation or due to lack of liquidity). This is a major contradiction that is at the source of market dysfunctions.

Read Full Article on FT.com/alphaville: The Problem with Commodity ETFs

Thanks to @todaytrader on twitter for finding this link.  Had dinner with Andy and Steve of TodayTrader.com at the LA EXPO this year and know they’re the real deal. Great traders and great guys.

**Disclosure: long UNG as of this post **

Trading ETFs? Watch FINZ.tv’s popular show ETF in 60!

Interested in trading commodities and futures directly instead of via ETFs?  Check out this video tutorial How To Trade Crude Oil in 90 seconds