FAQ’s on Crude Oil Futures

FAQ’s on Crude Oil Futures

11 Junt 2018

1. Please elaborate on the basics of Crude Oil Futures
Futures contracts, including trading in crude oil futures, are financial instruments that carry with them legally binding obligations. The buyer and the seller have the obligation to take or make delivery of an underlying instrument at a specified settlement date in the future. Oil futures are a part of the derivatives family of financial products as their value is derived from the underlying instrument. These contracts are standardized in terms of quality, quantity and settlement dates.

2. What is the meaning of Crude Oil Futures?

The world’s most actively traded commodity is crude oil, which is unrefined oil and which is a popular source of energy and energy-related products. Contracts on many different types of oil are traded on exchanges throughout the world. In the United States, the New York Mercantile Exchange (NYMEX) is the major trading exchange for crude oil futures contracts. In the United Kingdom, the major trading venue is the International Petroleum Exchange.

Light-sweet crude oil is preferred by refiners because of its ability to yield high levels of gasoline, diesel fuel, heating oil, and jet fuel. Other trading exchanges throughout the world also trade futures and options on many varieties of crude oil. The benchmark light-sweet crude oil contract that NYMEX bases its contract on is the West Texas Intermediate (WTI) crude oil that is delivered in Midland, Texas.

Cash prices for WTI are quoted at Cushing, Oklahoma, which is a major crude oil shipment point that has extensive pipeline connections to oil producing areas and the Southwest and Gulf Coast-based refining centers.

3. Which are the exchanges where Crude is traded?

The main futures exchanges are the New York Mercantile Exchange (NYMEX) and the Intercontinental Exchange (ICE), where West Texas Intermediate (WTI) and North Sea Brent crude oil are traded respectively. The Multi Commodity Exchange of India Limited (MCX)also offers Crude WTI future contract which derives its prices from NYMEX WTI Crude Oil Futures and following FSP of this product.

4. Explain the following - NYMEX, ICE, and WTI.

There are futures markets for a number of instruments ranging across currencies, bonds, equities, interest rates, and commodities. In the case of crude oil, the main futures exchanges are the New York Mercantile Exchange (NYMEX) and the Intercontinental Exchange (ICE), where West Texas Intermediate (WTI) and North Sea Brent crude oil are tradedrespectively.

These exchanges trade what is referred to as “light-sweet” crude oil, and a single contract – also known as a “lot” – calls for the purchase or sale of 1,000 barrels of oil. Traders can buy and sell oil for delivery several months or years ahead.

The bulk of activity in commodity futures markets is typically concentrated on oil for delivery in the next three months. However, in the past five years, activity has increased substantially for deliveries much further into the future as more investors put money into commodity indices.

5. What are Crude Oil Futures on MCX?

Crude oil is the most actively traded commodity on MCX. The combined value of crude oil (across all contracts) traded on MCX, on average, exceeds Rs. 6,000 crores on a daily basis. This translates to roughly 13,000 barrels of crude oil traded daily. Active market participation in crude oil comes in from both corporate and retail individual traders. On any given day, you can expect both upstream companies (ONGC, CAIRNand Reliance) and downstream companies (IOC, BPCL and HPCL) placing orders on MCX - these institutional orders are mainly to hedge their exposure in the spot (physical) market. On the other hand, the retail traders mostly speculate on the crude oil prices.

6. How Are Oil Futures Traded?

Futures contracts are traded on the regulated futures exchanges. Trading can take place through electronic dealing systems, open outcry around a pit, or a combination of both. To trade on an exchange, you need to be a member of that exchange. Exchange members can trade on their own account, or they can execute orders for hedgers or speculators. In the latter case, exchange members are acting as brokers and will collect a fee for their service. Each futures exchange has a clearing house which ensures that trades are settled in due accordance with the market rules, and that guarantees the performance of the contracts traded.

7. Please elaborate on the basics of trading Crude Oil Futures.

Crude oil is one of the better commodities to trade. It is a very active market and it is well known to investors around the world. There is usually no shortage of news to cause the price of oil to move from day to day. This presents many good trading opportunities, whether you focus on day trading futures or you are a longer-term trader or investor.

Crude oil is one of the most actively traded commodities in the world.

The price of crude oil affects the price of many other assets including stocks, bonds, currencies, and even other commodities. This is because crude oil remains a major source of energy for the world.

8. What is the role of Clearing Houses in Crude Oil trading at NYMEX?

The NYMEX operates its own clearing house. In the UK, the London Clearing House (LCH.Clearnet) is a recognized house that clears business for many different exchanges. The ICE exchange is also recognized as a clearing house by the UK regulator, the Financial Services Authority (FSA).

In the US, the equivalent government regulator is the Commodity Futures Trading Commission (CFTC). When a buyer and a seller agree to trade on futures exchanges, their transaction is recorded. The clearing house then steps in between them, in effect breaking the “bond” between the buyer and the seller to become a counterparty to both the sides. The process of creating a trade by the name of the clearing house to each of the parties is often referred to as “novation”.

The clearing house, among other roles, is responsible for the management of the risk on transactions on the exchange. It establishes margin levels, default rules, and ensures the settlement of individual positions.

When market participants buy futures, they do not pay the full amount of value of the contracts they purchase. Rather, they pay an initial margin that acts like an insurance deposit, the amount of which is determined by the clearing house.

This initial margin represents a percentage of the value of the transaction. At the end of each trading day, individual positions are evaluated relative to the closing price of the market published by the exchange. Participants are then said to be “Marked ToMarket”.

If their position is profitable, it will accrue into their account. In contrast, if the position is not profitable, the loss will be deducted from the initial deposit, and the participant will be given a “margin call” – also known as the variation or maintenance margin – to make up the difference.

On the settlement date, or the expiry of a futures contract, the buyer and seller have the obligation to make or take delivery of the instrument. In the case of oil, settlement can be carried out in two ways - through the actual delivery of oil into a predefined location or through a cash settlement.

9. Is physical Delivery possible in Crude Oil?

In the case of the NYMEX WTI contract, physical delivery is possible and entails delivery into the oil hub of Cushing, Oklahoma. On the ICE Brent contract, there is no physical delivery, but a cash settlement is available. The value of the position is assessed relative to the settlement price and a corresponding financial payment is made.

In reality, physical delivery rarely takes place in commodity futures. At the same time, market participants do not necessarily need to wait for the expiry of their contracts to settle their obligations vis-à-vis the exchange.

Positions are often closed by taking an offsetting position for an equal and opposite amount of contracts. For example, a buyer of certain futures can therefore sell anequal amount of those futures, making their net obligation relative to the exchange zero.

10. Which factors affect Crude Oil Prices?

Light Sweet Crude Oil is traded on the New York Mercantile Exchange (NYMEX). "Light Sweet" is the most popular grade of crude oil that is traded. Another grade of oil is Brent Crude, which is primarily traded in London. Crude oil is the raw material that is refined to produce gasoline, heating oil, diesel, jet fuel and many other petrochemicals.

Russia, Saudi Arabia, and the United States are the world’s three largest oil producers. When crude oil is refined or processed, it takes about 3 barrels of oil to produce 2 barrels of unleaded gas and 1 barrel of heating oil.

11. Which Crude Oil Reports should we watch regularly?

The main reports for crude oil are the EIA Weekly Energy Stocks report. This report is released every Wednesday around 8 PM IST.

12. How do US weather conditions influence Crude Prices?

The prices of unleaded gas and heating oil can influence the price of crude oil. Demand is generally the highest during the summer and winter months. A very hot summer or very active driving season (for summer vacations) can increase the demand for crude oil and cause prices to move higher.

An extremely cold winter causes higher demand for heating oil, which is made from crude oil. This usually causes prices to move higher. Watch the weather in the Northeast, since this is the part of the country that predominately uses heating oil.

Also Watch for oil production cuts or increases from OPEC.

13. How do geopolitical issues affect Crude Prices?

Crude oil can be a volatile market. Major news events can happen overnight and cause the price of oil to have wide swings. The same thing can happen throughout the day, whether it is due to an economic report or tensions in the Middle East. A tight supply situation can considerably exacerbate price movements.

Supply and demand obviously dictate how the price will move, but this market often moves on emotion. Much of that comes from the unknown. If tensions escalate in the Middle East, there is no telling the extent of possible supply disruptions.

Traders will often react swiftly on the news and then sort it out later.

14. Which are the major price moves that have happened in Crude Oil?

The reason why prices move so swiftly is that traders who have short positions in the market tend to cover quickly. In order to do this, they have to place buy orders to cover. This wave of buying is done at the same time speculators are jumping on board to establish or add to long positions. The shorts will cover quickly because the risk is just too great if it is really a major development that could disrupt supplies.

The usual tendency is for oil prices to have a sharp spike higher on turmoil in the Middle East. Subsequently, the prices calm down and start to move lower unless we start to see a very clear evidence of major supply disruptions. Identifying these waves of buying and selling are very important if you want to avoid getting whipsawed in the markets on emotions.

15. How does crude oil tend to be a trending market?

For the most part, crude oil tends to be a trending market. There is usually a major bias to the upside or downside. Trading from the trending side will certainly help improve your odds of success. Crude oil also tends to get stuck in prolonged ranges after a sizable move. If you can identify these ranges, there are plenty of opportunities to buy at the low end and sell at the high end. Generally, traderslike to trade the ranges until there is a clear breakout either way.

16. How does the US Dollar affect Crude Oil Price Movements?

The value of the U.S. dollar is a major component in the price of oil. A higher dollar will put pressure on oil prices. A lower dollar helps support higher oil prices. Crude oil also tends to move closely with the stock market. A growing economy and stock market tends to support higher oil prices. However, if oil prices move too high, it can stifle the economy. At this point, oil prices tend to move opposite the stock market. This usually becomes a concern when oil moves above $100.

17. Is day trading possible in Crude Oil?

Yes. Like any other financial instrument, you can do day trading in Crude Oil futures by paying a margin which is approximately 6%-8% of the contract value in MCX.

Crude oil is one of the favorite markets of futures day traders. The market typically reacts very well to pivot points and support /resistance levels. You have to make sure you use stops in this market, as it can make very swift runs at any given time. Long time energy trader, Mark Fisher, wrote an excellent book on day trading oil futures titled The Logical Trader.

There is no shortage of trading opportunities in crude oil from day to day. The market is very active and it has plenty of volumes. Beware of possible overnight moves that can take you by surprise. Much of the same principles that apply to stock index futures also apply to crude oil futures. If you like trading the E-mini S&P, you will probably like crude oil too.

18. What arethe current Crude Oil Futures Trend?

Crude oil entered a bear market in June 2014 when the price was just under $108 per barrel on the active month NYMEX crude oil futures contract. By February 2016, the price depreciated to under $30 per barrel. We have seen amazing recovery in crude oil prices from a low of $30 to $71 in the last 1.5 years.

19. What is the impact of Crude Oil Futures on other segments?

Even if they do not trade or invest directly in crude oil, investors and traders all over the world follow the price of the energy commodity. When it comes to stock markets, there are so many companies involved in the exploration, production, processing, and servicing of the oil industry that moves in the price of crude oil effect major equity market indices around the world.

Crude oil affects debt markets for a number of reasons. Oil companies require vast sums of capital for production and other oil-related projects around the world. The amount of money lent by banks to the oil industry is significant. During slumps in the price of oil, defaults on oil-related loans have an important impact on the overall debt markets.

Additionally, many nations around the world depend on crude oil revenues; therefore, changes in the price of oil can directly affect government debt and currency levels in producing countries. When it comes to other commodities, energy is an important cost of goods sold a component of production. Therefore, the price of crude oil directly affects the production cost of other raw materials.

While consumers do not buy raw crude oil, petroleum products like gasoline, heating oil, diesel and jet fuel and others are basic necessities for individuals around the world on a daily basis. The price of crude oil has a direct impact on most people that inhabit the earth. Crude oil futures, or derivatives, reflect the prices of the physical petroleum markets around the world. Understanding the physical flows of oil from producers to consumers is an imperative when it comes to being a knowledgeable trader or investor. 

20. Crude Oil - Contract Specification on MCX

  • Symbol: Crude Oil
  • Trading Unit: 100 Barrels
  • Quotation: Rs. Per Barrel
  • Tick Size: Re.1
  • DPR: 4% and then revised
  • Initial Margin: Minimum 4% or based on SPAN, whichever is higher
  • Maximum Allowable open position: For individual 4,80,000 barrel or 5% of the market wide open position whichever is higher
  • Contract Month: Monthly from January to December
  • Quality Specification: Light Sweet Crude Oil confirming to the following specification- Sulphur 0.42% by weight or less, API gravity: between 37 degrees – 42 Degrees

21. Crude Oil - Contract Specification on CME (NYMEX)

  • Exchange Symbol CL
  • Contract Crude Oil West Texas Intermediate
  • Exchange NYMEX
  • Tick Size 1 cent per barrel ($10.00 per contract)
  • Daily Limit $10.00 per barrel ($10,000 per contract)
  • Contract Size 1,000 U.S. barrels (42,000 gallons)
  • Trading Months All Months
  • Trading Hours 5:00p.m. - 4:00p.m. (Sun-Fri) (RTH 8:00a.m. - 1:30p.m.) CST
  • Value of One Futures Unit $1,000
  • Value of One Options Unit $1,000
  • Last Trading Day Trading terminates at the close of business on the third business day prior to the 25th calendar day of the month preceding the delivery month

22. Brent Oil - Contract Specification on ICE

  • Exchange Symbol BZ
  • Contract Brent Crude Oil Financial Futures
  • Exchange NYMEX
  • Tick Size 1 cent per barrel ($10.00 per contract)
  • Daily Limit None
  • Contract Size 1,000 U.S. barrels (42,000 gallons)
  • Trading Months All Months
  • Trading Hours 5:00p.m. - 4:00p.m. (Sun-Fri) CST
  • Value of One Futures Unit $1,000
  • Value of One Options Unit $1,000
  • Last Trading Day Trading terminates on the last UK business day of the second month prior to the delivery month

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