How To Make Sense Of Crude Oil Futures
The stock market has traditionally proved to be a fantastic platform for investors to trade financial instruments, and similarly commodities are traded by way of an investment vehicle known as a “future”. The “future” is a financial instrument that the investor uses to take a position on where the investor feels that the price of the underlying commodity will move in the future. The futures trader purchases this vehicle with the belief that the price of the commodity will either increase or decrease at a certain predetermined future date.
The purchase of a future is a contract that locks in the price today so that the purchaser can acquire the underlying commodity in the future at today’s agreed upon price regardless of any possible market conditions in the future (the agreed upon date). Globally there are numerous futures markets, and for petroleum the largest markets are the New York Mercantile Exchange (NYMEX) along with the International Petroleum Exchange, which is now known as “ICE”.
There is a lot of speculation that takes place on the futures markets, and this can have an effect on the price of crude oil. For example, if traders acquire large quantities of futures at prices that are higher than the current market price, this will cause for oil producers to hoard their supply currently at hand so that they can then dump it on the market in the future at the at the new higher price-this promptly cuts of the current supply of oil to the marketplace and simultaneously drives up both the future and present price of the commodity. Sometimes traders try to “Corner the market” by using this well known technique.
During the 1970s the Commodity Futures Trading Commission (CFTC) was established in the United States as a government body to regulate speculators and keep things in check so that prices do not spiral out of control. Gradually over time, the CFTC relinquished much of its regulatory power and control over the market.
Just like any other commodity, crude oil has its own ticker symbol and margin requirements for trading on the exchanges. If an investor/trader was trading a crude oil futures contract they will see something like this on the ticker tape:
CL8K @ 103.45
The text in the above bold faced font translates to read “Crude Oil (CL) 2008 (8) May (K) at $103.45/barrel.” The value of an oil contract is determined by the current market price multiplied by the value of the contract. So in this example: $103.45 X 1000 oil barrels = $103 450