By Brad Zigler

Last Friday, the spot NYMEX crude oil contract-the reference price for the funds-was near the threshold $111-per-barrel level that could trigger liquidation of the shares' underlying trust.

For some, the disappearance of UCR and DCR would be a welcomed end to the confusion that has constantly swirled ‘round these novel securities. A lot of people have been plenty bewildered by the seemingly wide and sometimes nonsensical premia and discounts exhibited by the portfolios (see "Caveat Emptor,").

At last look, the UCR ("Oil Up") fund was trading at a 13.6% discount to its net asset value while DCR (the "Oil Down") shares commanded an 88.8% premium. Holders of the MacroShares portfolios are left scratching their heads as to how this situation developed as oil rose over $40 per barrel during MacroShares' tenure. They're also wondering, not surprisingly, what's going to happen to these spreads from here.

First things first. Yes, percentagewise, the premium for UCR seems wildly out of line with the DCR discount. Dollarwise, however, the premium and discount are nearly identical and pretty much offset one another (see the chart, "MacroShares Premium/Discount" below). It's only because of the whittling of the DCR fund's price since inception and the concomitant appreciation in UCR's that the percentages seem so disparate.

So, why'd that happen?

Because DCR shares and UCR shares are created as complementary pairs of securities, that's why. UCR shareholders and DCR shareholders tap into a common pool of assets, transferring value back and forth with the vagaries of crude oil price movements.

Authorized Participants ["APs"] have to create and redeem fund shares in 50,000-share blocks. If an AP wants to capture the DCR premium (at last look, $4.69 per share), it would be obliged to create a pair of UCR/DCR units (blocks of 50,000 shares) at NAV and sell them into the open market. The DCR premium captured through the sale, however, would be more than eaten up by a contemporaneous $4.72-per-share discount earned on the UCR shares, plus transaction costs. Not much of an arb opportunity, that.

But why the premium and discount in the first place?

Think about that $111-per-barrel termination trigger. If the NYMEX front-month contract settles at or above $111 for three consecutive days, the MacroShares trusts would be liquidated at NAV. In a heartbeat, so to speak, the complementary premium and discount would evaporate. In essence, there's an embedded option (a collar, really) within each share of DCR and UCR. It's the call component of the collar-the option that becomes more valuable as the underlying asset appreciates--that's likely to be exercised by current market action now.

And it's that which drives the DCR premium (and the UCR discount). The premium is really the value of the embedded option obtained.

And what's that worth? Well, a share of DCR entitles its buyer to the NAV ($5.28 at last look), together with the equivalent of a short on 1/3 of a barrel of crude oil (it's a third because of a 3-for-1 share split last year), overlaid with a call on the NAV at a $3 strike price (that's 1/3 of $120-the underlying trust's starting asset value-less the $111 termination trigger price).

There ... that should be as clear as West Texas Intermediate.

MacroShares Premium/Discount

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