Trading Oil can be a very lucrative way of speculating in the financial markets however, as with Gold, we urge caution. It is a highly volatile commodity and spreads are larger than currency investments.
The basic building blocks for all CFDs are the Futures and swaps contracts. For the energy markets these are traded in New York NYMEX, in Tokyo TOCOM and on-line through the Intercontinental Exchange.
A future is a contract to deliver or receive oil (in the case of an oil future) at a defined time in the future. The price is agreed on the date the investment/agreement is struck together with volume, duration, and contract index. The price for the futures contract at the date of delivery (contract expiry date) may be different. At the expiry date, as with all CFDs, depending upon the contract specification the ‘futures’, they may settle in cash against an expiration price set by the exchange, or they may close out the contract prior to expiry and pay or receive the difference (profit or loss) in the two prices. In futures markets you always trade with a formal exchange, every participant has the same counterpart.
A CFD is an agreement whereby a floating price is exchanged for a fixed price over a specified period. It is a financial arrangement that involves no transfer of physical oil, both parties settle their contractual obligations by means of a transfer of cash and no fiscal oil changes hands. The agreement defines the volume, duration, fixed price and floating price. Differences are settled in cash for a specific time. The amount of cash is determined as the difference between the price struck at the initiation of the CFD and the settlement of the index. In a CFD contract you trade with your counterpart (a company/institution/individual) and take risk on their capacity to pay you any amount that may be due at settlement.
The first energy derivatives covered petroleum products and emerged after the fundamental restructuring of the world petroleum market in the 1970s. At roughly the same time energy products began trading on derivatives exchange with crude oil, heating oil, and gasoline futures on NYMEX and gas oil and Brent crude on the International Petroleum Exchange (IPE).
There are 3 principal applications for the energy derivative markets:
- Risk Management (“Hedging”) as with Gold
- Speculation (“Trading”)
- Investment Portfolio Diversification
This describes the process used by corporate businesses, governments, and financial institutions to reduce their risk exposures to the movement of oil prices. The classic example provided by all text books is the activity of an airline company, jet fuel consumption represents up to 23% of all costs. The airline seeks to protect itself from rises in the jet fuel price in the future. In order to do this, it purchases a swap or a call option linked to the jet fuel market from a Broker/MM that trade in these commodities. Any subsequent rise in the jet price for the period is protected by the derivative transaction. A cash settlement at the expiry of the contract will fund the financial loss incurred by any rise in the fiscal jet fuel.
Types of Oil
The most commonly known and traded are obviously Brent Crude and WTI Crude however there are many more.
Saharan Blend, Algeria, Minas, Indonesia, Bonny Light Nigeria, Arab Light, Saudi Arabia, Fateh, Dubai, Tia Juana Light, Venezuela, Isthmus, Mexico, Russian Export blend,