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CRUDE OIL FITUREs TRADING

Presentation · April 2016

DOI: 10.13140/RG.2.1.4568.6648

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 Lecture # 13
CRUDE OIL
FITUREs
TRADING
Futures trading is risky and not suitable
for everyone. Past performance is not
indicative of futures results.

© Hassan Harraz 2016

Outline of Lecture
1) CRUDE OIL FUTURES TRADING BASICS
Why Trade Futures?
How to Start Trading Crude Oil Futures
1.1) Hedging
1.2) Speculation
1.2.1) Example of a Futures Trade
1.3) Complex Strategies
2) THE FUTURES OF CRUDE OIL MARKET
2.1) The Market for Brent
2.2) The Spot Market, or “Dated Brent”
2.3) The Forward Market, or “15-day Brent”
2.4) The Structure of the Oil Market
2.5) How is the Market Cleared?
2.6) The Feedback Issue
2.7) OPEC and Brent / WTI prices
2.8) Other influences
3) DIFFERENCE BETWEEN LIGHT SWEET CRUDE AND BRENT CRUDE TRADING
4) CRUDE OIL TRADING CONTRACTS
5) CRUDE OIL FUTURES CONTRACT SPECIFICATIONS
5.1) Symbol
5.2) Contract Size (or Trading Unit)
5.3) The Underlying
5.4) Exchange
5.5) Price Quotation
5.6) Grade of Deliverable
5.7) Delivery Date
5.8) Last Trading Day
5.9) Delivery Months
© Hassan Harraz 2016
KEY DRIVERS OF THE ENERGY FUTURE

• GDP & pop. growth • significant resources

• urbanisation Demand Supply • Unconventionals
• demand mgmt. Growth Challenges

Technology
and policy

• local pollution Environmental Security • dislocation of resources

• climate change Impacts of Supply • import dependence

© Hassan Harraz 2016 3

1) CRUDE OIL FUTURES TRADING BASICS
In this era of globalization and internet, trading around the world has become very simple. Now People
are doing trading sitting right in their homes but there is yet a trading field which has very high profit
potentials and is still unexplored. This field is none other than Oil trading. Trading oil is exactly the same
as trading Forex, stocks , or anything ….else.
Oil Trading, as opposed to buying shares, allows two big advantages:
 The first is that we can profit from falling prices just the same as rising prices, by selling rather
than buying.
 The second is 'leverage' which allows us to effectively buy huge quantities with just a small
deposit.
 This means we can pocket a decent profit from a small move up or down in price. Of course, this
is potentially risky but we always put in an automatic 'stop loss' to close the trade. So, that if the
price moves against us by a set amount then we can control the damage.
Likewise, we put in an automatic 'limit' to close the trade for a set profit. Many Forex brokers also allow
you to trade oil.
The amount of capital you require for oil trading varies from broker to broker but most will trade mini
contracts and need only a few hundred dollars in your account.
There are two types of Prices going on in the Oil market, namely spot price and future price:
The futures price is simply an estimated price for oil for delivery at a set date in the near future. It
really makes no difference to our trading.
Trade in crude oil futures these various markets is relatively simple because all the same basic factors
that contribute to the economic and in their prices.
 Trade in crude oil futures these various markets is relatively simple because all the same basic factors
that contribute to the economic and in their prices.

© Hassan Harraz 2016 4

1) CRUDE OIL FUTURES TRADING BASICS…(Cont.)
 Crude Oil futures are standardized, exchange-traded contracts in which the contract
buyer agrees to take delivery, from the seller, a specific quantity of crude oil (eg. 1000
barrels) at a predetermined price on a future delivery date.
 A futures contract is a standardized contract that calls for the delivery of a specific
quantity of a specific product at some time in the future at a predetermined price. Futures
contracts are derivative instruments very similar to forward contracts but they differ
in some aspects.
 Futures contracts are traded in futures exchanges worldwide.
 Consumers and producers of crude oil can manage crude oil price risk by purchasing
and selling crude oil futures. Crude Oil producers can employ a short hedge to lock in a
selling price for the crude oil they produce while businesses that require crude oil can
utilize a long hedge to secure a purchase price for the commodity they need.
 Crude Oil futures are also traded by speculators who assume the price risk that hedgers
try to avoid in return for a chance to profit from favorable crude oil price movement.
Speculators buy crude oil futures when they believe that crude oil prices will go up.
Conversely, they will sell crude oil futures when they think that crude oil prices will fall.
Last thing, do keep in mind that …Oil Trading in futures involves a high degree of risk
and is not suitable for all investors.

© Hassan Harraz 2016 5

Why Trade Futures?
The primary purpose of the futures market is to allow those who wish to
manage price risk (the hedgers) to transfer that risk to those who are willing
to take that risk (the speculators) in return for an opportunity to profit.

How to Start Trading Crude Oil Futures

To buy or sell crude oil futures, you need to open a
trading account with a broker that handles futures
trades. Most online brokerages out there only deal with
stocks and stock options.

© Hassan Harraz 2016 6

1.1) Hedging
 A producer can sell futures or buy put options to ensure a minimum level of
prices.
 A large consumer can buy futures or a call option to ensure against very high
prices
 Major companies are on both sides of the market and may be doing both
things at the same time.
 Producers and manufacturers can make use of the futures market to hedge
the price risk of commodities that they need to purchase or sell in order to
protect their profit margins.
 Businesses employ a long hedge to lock in the price of a raw material that
they wish to purchase some time in the future.
 To lock in a selling price for a product to be sold in the future, a short hedge
is used.

© Hassan Harraz 2016 7

Oil futures are derivative securities that give the holder the right
to purchase oil at a specified price (similar to how stock
options work). Oil futures are one of the most liquid investments
because of the high volume that is traded every day. In fact, they
are one of the most actively traded future on the market.

Investing in oil futures can be a great strategy. There are

opportunities for investors as well as risks. Before you start
investing in oil futures, make sure you know what you are doing.
Know what affects the prices of oil and when the best time is to
purchase. Even the professionals get timing wrong, so be realistic
with yourself before you commit to investing.

© Hassan Harraz 2016 8

Crude Oil Futures Short Hedge vs. Crude Oil Futures Long Hedge

Crude Oil Short Hedge Long Hedge

Futures
Hedging Against Falling Crude Oil Prices
using Crude Oil Futures
Crude Oil producers sell:
 can hedge against falling crude oil
price by taking up a position in the
crude oil futures market.
 can employ what is known as a short
Definition hedge to lock in a future selling price
for an ongoing production of crude oil
that is only ready for sale sometime in
the future.
To implement the short hedge {i.e., crude
oil producers sell (short)} enough crude oil
futures contracts in the futures market to
cover the quantity of crude oil to be
produced.
The downside of the short hedge:
is that the crude oil seller would have
been better off without the hedge if the
Risk/Reward price of the commodity went up.
An alternative way of hedging against  An alternative way of hedging against
Tradeoff falling crude oil prices while still be able to
benefit from a rise in crude oil price is to
buy crude oil put options.
Hedging Against Rising Crude Oil Prices
using Crude Oil Futures
Businesses that need to buy significant
quantities of crude oil
 can hedge against rising crude oil price
by taking up a position in the crude oil
futures market.
 can employ what is known as a long
hedge to secure a purchase price for a
supply of crude oil that they will require
sometime in the future.
To implement the long hedge, enough
crude oil futures are to be purchased to
cover the quantity of crude oil required by
the business operator.
 The downside of the long hedge:
is that the crude oil buyer would have
been better off without the hedge if the
price of the commodity fell.
rising crude oil prices while still be able to
benefit from a fall in crude oil price is to
buy crude oil call options.

© Hassan Harraz 2016 9

1.2) Speculation
 Speculators assume the price risk that hedgers try to avoid in return for a
possibility of profits. They have no commercial interest in the underlying
commodities and are motivated purely by the potential for profits. Although
this makes them appear to be mere gamblers, speculators do play an
important role in the futures market.
 Without speculators bridging the gap between buyers and sellers with a
commercial interest, the market will be less fluid, less efficient and more
volatile.
 Futures speculators take up a long futures position when they believe
that the price of the underlying will rise. They take up a short futures
position when they believe that the price of the underlying will fall.
1.2.1) Example of a Futures Trade
In March, a speculator bullish on soybeans purchased one May Soybeans
futures at $9.60 per bushel. Each Soybeans futures contract represents 5000
bushels and requires an initial margin of $3500. To open the futures position,
$3500 is debited from his trading account and held by the exchange
clearinghouse.
Come May, the price of soybeans has gone up to $10 per bushel. Since the
price has gone up by $0.40 per bushel, the speculator can exit his futures position
with a profit of $0.40 x 5000 bushels = $2000.

1.3) Complex Strategies

 A producer can at the same time buy a put option and sell a call option: in the first step he
acquires a guarantee of future revenue, in the second he gives up the extra profit from
potential price peaks.
 The purchase of a put is financed by the sale of a call. The combination of a put and a call
is called a “Collar”.
© Hassan Harraz 2016 10
Long future position vs Short future position

© Hassan Harraz 2016 11

Why oil producing countries like reference pricing?
 Accepting pricing out of a marker implies that producers are giving up on an
important role.
 They should naturally be price makers, instead are price takers.
 Why? First and foremost because in the past they failed in the management
of posted prices.

Why there is no Arabian Light market?

 Setting up a market for a major crude, such as e.g. Arabian Light, is not
easy because there is just one seller.
 The seller does not want the responsibility of making prices, because
he is afraid of international political pressure or domestic dissension.

© Hassan Harraz 2016 12

What is a paper barrel?
 A paper barrel is an oil cargo which is sold and traded on the open market, but not actually
shipped; essentially, the cargo is passed back and forth on paper, hence the name "Paper
Barrel."
 Obviously at some point the cargo of oil will be delivered, but it may have changed hands
several times in paper barrel form before delivery actually happens.
 Trading in paper barrels, as you might imagine, can drive the price of oil up considerably, and
in periods when oil prices appear to be rising precipitously, many people suspect that trading in
paper barrels may be the culprit.
 The idea of trading goods on paper but not actually taking delivery is actually fairly old, as is
speculation in such cargoes.
 Many areas have a long history of futures trading for things like pork bellies, wheat, corn, and
so forth. Futures trading had its origins in farmers who would travel to an urban area to get
contracts to sell their crops in advance of actually having a crop to sell.
 By reaching an agreed-upon price early, many farmers hoped to ensure a base profit for their
crop, but they were also making a bet that crop prices wouldn't rise substantially.

Why so many Paper Barrels?

 Most participants in the futures market are there to manage their risk, not to acquire Brent crude.
 Buying and selling Brent futures and options is an effective strategy because other crude prices
follow Brent movements.

© Hassan Harraz 2016 13

© Hassan Harraz 2016 14
3) DIFFERENCE BETWEEN LIGHT SWEET CRUDE AND
BRENT CRUDE TRADING
You must have heard names such as Brent or WTI. We are going to have a short view of the difference between Light
Sweet Crude and Brent Crude Trading for more understanding of the market you’re earning
 Brent or WTI, both are the most important varieties of oil. According to oil density, it is divided into various
categories. Each type of oil does not differ only in the gravity, but also in the molecular characteristics, in the
composition of elements and the content of sulfur.
 The prices of the Oil varieties are also different. But here, there is an interesting thing to note that unlike other
commodities, a higher quality oil variety may not be costing more than the lower quality Oil and it’s quite possible
that lower quality oil may be costing more. Below I discuss the two main varieties in relation to oil trading.
 First oil variety is called WTI (West Texas Intermediate). This is the most important variety. This oil is also known
as Texas Light Sweet (Sweet Texas Crude). This oil is extracted in the U.S. Its most important center is Cushing in
Oklahoma. WTI is in the best varieties.
 WTI oil price is the most important price. That is, if you read a story in which the oil reaches $100 a barrel, it is the
variety WTI. The WTI price is the global reference point (benchmark) of oil. However, many debates that despite of
WTI quality, it does not represent the type of oil which should represent the world price.
 It should also be noted that it is increasingly difficult to extract oil of this quality and gradually the quality is also going
down. It is listed on the NYMEX in New York.
 Second Oil variety is called BRENT. This is one of the most important types of oil. In fact it is a mixture of
varieties: Brent Crude, Brent Sweet Light Crude, Oseberg, Ekofisk, Forties .It is also known as Brent Blend.
 The price of Brent is used to price two thirds of all international oil business. This type of oil is also used as a point of
reference, and we can see it in the news and newspapers. Brent crude produced in the North Sea, is a high quality
oil (less than WTI).It trades on the ICE.
 Although, the WTI crude oil is of better quality but it happens that BRENT oil costs more than WTI. Around four to
five years ago, the difference between the price of Brent and WTI was around 10 USD.
 In recent days, due to the lack of capacity for refinement, WTI began to lose its attachment to the world price and
now despite having more quality, it is cheaper than Brent. Another thing to note here is that the oil prices are directly
related to the political situation of the world.
 Various political forces change the prices in their favour by increasing or decreasing the supply. So, if you are
interested in oil trading whether it is light sweet crude or Brent crude trading then you must remain up-to-date in
© Hassan Harraz 2016 15
international news or at least news of major oil producing countries.
4) CRUDE OIL TRADING CONTRACTS
i) Future contracts:
is an agreement that represents a specific quantity of the underlying commodity to be
delivered some time in the future for a pre-agreed price.
Unlike options, buyers and sellers of futures contracts are obligated to take or make delivery of
the underlying asset on settlement date.
ii) Option contracts:
is an agreement between a buyer and seller that gives the purchaser of the option the right to
buy or sell a particular asset at a later date at an agreed upon price. Options contracts are
often used in securities, commodities, and real estate transactions. Options characteristically
exist in one of two forms:
Call options, which give the beneficiary the right to require the grantor to sell or convey
the property to them at the agreed price on exercise
Put options, which give the beneficiary the right to require the grantor to buy or receive
the property at the agreed price on exercise.
Call and put options may be combined to design complex risk management strategies.

Trading Symbol:
 Futures: CL
 Options: LO

What are options for?

 Any buyer or seller on the petroleum market faces a price risk.
 Options and futures allow parties facing a structural risk to limit that risk, “selling” it to
speculators (or “insurers”).

© Hassan Harraz 2016 16

5) CRUDE OIL FUTURES CONTRACT SPECIFICATIONS
 Oil futures are derivative securities that give the holder the right to purchase oil at a
specified price (similar to how stock options work).
 Oil futures are one of the most liquid investments because of the high volume that
is traded every day. In fact, they are one of the most actively traded future on the
market.
 The world market prefers light, sweet crude oil, largely because it requires less
refinement and production time before going to market.
 Light crude oil is more desirable than heavy oil because it produces higher yields of
gasoline, while sweet oil commands a higher price of oil.
 Investing in oil futures can be a great strategy. There are opportunities for investors
as well as risks. Before you start investing in oil futures, make sure you know what
you are doing. Know what affects the prices of oil and when the best time is to
purchase. Even the professionals get timing wrong, so be realistic with yourself
before you commit to investing.
5.1) Symbol
Each futures contract traded in a futures exchange is identified by a unique ticker
symbol (CL).

© Hassan Harraz 2016 17

 Chart of Light Crude Oil futures updated April 4, 2013.

www.cannontrading.com | Call - (800) 454-9572

Futures trading is risky and not suitable for everyone. Past performance is not indicative of futures results.
© Hassan Harraz 2016 18
5.2) Contract
Trading Unit - CrudeSize (or trade
Oil Futures Trading
in units Unit)
of 1,000 U.S. barrels (42,000 gallons). Options: One
NYMEX Division light, sweet crude oil futures contract
The contract size states the
amount and unit of the
underlying commodity
represented by each futures
contract.
Crude Oil Futures trade in
units of 1,000 U.S. barrels
(42,000 gallons) {(1 contract =
1000 barrels)}. Options: One
NYMEX Division light, sweet
crude oil futures contract.

www.cannontrading.com | Call - (800) 454-9572

Futures trading is risky and not suitable for everyone. Past performance is not indicative of futures
results.
© Hassan Harraz 2016 19
5.3) The Underlying
Each futures contract represents a specific underlying asset to be delivered on
the delivery date. Besides commodities, other instruments such as interest rates,
currencies and stock indices are also traded in the futures exchanges.
5.4) Exchange
The futures exchange where the futures contract is traded. Crude oil began
futures trading on the NYMEX in 1983 and is one of the most heavily traded
commodities. Some of the world's largest futures exchanges include:
 Chicago Mercantile Exchange (CME)
 New York Mercantile Exchange (NYMEX)
 Tokyo Commodity Exchange (TOCOM)
 Multi-Commodity Exchange (MCX)
 Intercontinental Exchange (ICE)
 Dubai Mercantile Exchange (DME),
 India's National Commodity and Derivatives Exchange (NCDEX)

Exchange & Product Name Symbol Contract Size Initial Margin

NYMEX Light Sweet Crude Oil CL 1000 barrels USD 9,113 (approx. 23%)
Futures (Full Contract Spec) (Latest Margin Info)
NYMEX Brent Crude Oil BZ 1000 barrels USD 12,825 (approx. 29%)
Futures (Full Contract Spec) (Latest Margin Info)
TOCOM Crude Oil Futures - 50 kiloliters JPY 210,000 (approx. 17%)
(Full Contract Spec) (Latest Margin Info)

© Hassan Harraz 2016 20

Crude oil began futures trading on the NYMEX in 1983 and is one of the most heavily traded
commodities.

The New York Mercantile Exchange ( NYMEX) is a commodity futures exchange owned and operated by CME Group
of Chicago. NYMEX is located at One North End Avenue in Brookfield Place in the Battery Park City section of
Manhattan, New York City.
www.cannontrading.com | Call - (800) 454-9572
Futures trading is risky and not suitable for everyone. Past performance is not indicative of futures results.
© Hassan Harraz 2016 21
Futures contracts for crude oil are traded at the New York Mercantile Exchange (NYMEX),
Intercontinental Exchange (ICE), Dubai Mercantile Exchange (DME), Multi Commodity
Exchange (MCX), India's National Commodity and Derivatives Exchange (NCDEX) and the Tokyo
Commodity Exchange (TOCOM).

The New York Mercantile Exchange ( NYMEX) is a commodity futures exchange owned and
operated by CME Group of Chicago. NYMEX is located at One North End Avenue in
Brookfield Place in the Battery Park City section of Manhattan, New York City.
www.cannontrading.com | Call - (800) 454-9572
Futures trading is risky and not suitable for everyone. Past performance is not indicative of futures results.
© Hassan Harraz 2016 22
 Crude Oil Futures are quoted in dollars
and cents per barrel.

© Hassan Harraz 2016 23

5.5) Price Quotation ‫تحديد السعر‬
 Spot Prices and futures prices are different quotes for different types of contracts.
i) The SPOT PRICE is the current price of a spot contract, at which a particular commodity could
be bought or sold at a specified time, place for immediate delivery and payment on the spot date.
A security's spot price is regarded as the explicit value of the security at any given time in the
marketplace.
ii) The FUTURES PRICE is quoted for a financial transaction that will occur on a future date and is
the settlement price of the futures contract. The futures price is determined using the
commodity's spot price, the risk free rate and time to maturity of the contract. The futures price
is simply an estimated price for oil for delivery at a set date in the near future. A securities futures
price is the expected value of the security, in relation to its current spot price and time frame in
question. The futures price is simply an estimated price for oil for delivery at a set date in the
near future. It really makes no difference to our trading.
 The quoted price of a futures contract is the agreed price (per unit) of the underlying asset that the
buyer has to pay to the seller in order to take delivery of the goods.
 Correspondingly, it is also the price at which the seller must sell the underlying asset to the buyer.
 Crude Oil Futures are quoted in dollars and cents per barrel.
 One other important note to keep in mind is that purchasing an oil contract gives you ownership of
1,000 barrels of crude oil. This means that for every one dollar change in the price of oil, you will have
a profit or loss of $1,000 per contract. This aspect of futures even further adds to the risk and volatility
of investing in oil futures.

BREAKING DOWN 'Spot Price':

Spot prices are most often used in relation to pricing of futures contracts of securities, typically
commodities. The futures price is determined using the commodity's spot price, the risk free rate
and time to maturity of the contract (along with any costs associated with storage or convenience).
Using the same inputs, a security's spot price can also be determined given the futures price.

© Hassan Harraz 2016 24

5.6) Grade of Deliverable
The grade not only specifies the quality of the underlying but also the manner and the
exact place(s) of delivery.

5.7) Delivery Date

Each futures contract has a specific delivery date where the seller of the futures contract
is required to make delivery of the underlying product being traded and the buyer of the
futures contract is required to take delivery.

5.8) Last Trading Day

Trading shuts down some time before the delivery date to give the futures contract seller
sufficient time to prepare the underlying products for delivery. Futures positions which have
not been closed out (offset) before end of the last trading day will have to be settled by
making or taking delivery of the underlying product.

© Hassan Harraz 2016 25

5.9) Delivery (OR Trading ) Months:
Every futures contract has standardized months at which the underlying can
be traded for delivery.
Crude Oil Futures trade 30 consecutive months plus long-dated futures initially
listed 36, 48, 60, 72, and 84 months prior to delivery. Additionally, trading can be
executed at an average differential to the previous day’s settlement prices for
periods of two to 30 consecutive months in a single transaction. These calendar
strips are executed during open outcry trading hours. Options: 12 consecutive
months, plus three long-dated options at 18, 24, and 36 months out on a
June/December cycle.

www.cannontrading.com | Call - (800) 454-9572

Futures trading is risky and not suitable for everyone. Past performance is not
indicative of futures results.

© Hassan Harraz 2016 26

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