What Are Oil Futures
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What is an oil future?
An oil future is a bounded agreement to buy or sell an amount of crude oil at a future date. A typical oil futures contract represents 1,000 barrels of crude oil and has an expiration date ranging from one month to nine years.
It is important to note the price of oil is quoted per barrel even though contracts are sold in units of 1,000 barrels. This contract size provides traders an opportunity to greatly magnify gains and losses.
Oil futures are known for their volatility. Crude oil is one of the most in-demand and vital commodities in the world because of its use both as a fuel source and an unrefined base for other products. The demand for crude oil coupled with the commodity’s position as a representative of the world economy at large means futures traders follow the supply and demand of oil closely to anticipate market movement.
This volatility and size in which the contracts are sold has caused oil futures to grow from a niche contract traded among large companies to a popular speculation for retail traders, specifically swing and day traders.
Oil futures were traditionally bought by corporations that physically dealt with crude oil in their business dealings. However, large investment institutions such as hedge funds, mutual funds, and banks are now the biggest players in the oil futures market. Their breadth of monetary and analytical resources allows them to dedicate the time and attention needed to trade the expensive and risky futures contracts.
Oil companies still purchase futures from each other to obtain competitors’ assets at lower prices and limit their exposure to risks. Their insider position within the oil market gives them an advantage over other traders when it comes to future price speculation. Other companies that heavily rely on crude oil such as transportation companies and refineries also purchase oil futures to hedge risks and stabilize costs in the volatile market.
Increasingly more independent investors are also finding their way to the futures market. While it is generally advised traders only risk a small portion of their overall portfolio on these high-risk contracts, playing them right can result in massive returns. Although individual traders still make up a small portion of the crude oil futures trading and have little impact on the price changes in the market.
Oil futures are traded on both the New York Mercantile Exchange (NYMEX) and the Intercontinental Exchange (ICE) depending on the benchmark you are looking to trade. North America’s benchmark, West Texas Intermediary (WTI), is traded on the NYMEX under the ticker ‘CL’. Brent Crude serves as the benchmark across Africa, Europe, and the Middle East and is traded on the ICE under the ticker ‘BZ’.
WTI is primarily sourced from the Permian Basin in Southwest Texas, and Brent Crude is drilled from the North Sea between the UK and Norway. Compared to WTI, Brent Crude is normally priced higher because of its superior quality.
Online brokerages offer access to WTI on the New York Mercantile Exchange (NYMEX) and Brent Crude on the Intercontinental Exchange (ICE). Mini futures with contracts half the normal size can be traded on the CME Globex platform.
Once approved by a broker to trade futures, you will have to post a performance bond. These bonds are worth two to five percent of the futures contract value. You’ll also be required to post the initial margin requirement and retain the maintenance margin to keep the trade open. The amount you’ll pay varies depending on the capital in your account and the current price of oil futures contracts.
Keep reading for more info on both benchmarks and how to trade their futures contracts. Interested in the oil market as a whole? Read our guide to trading crude oil here.
You can buy and trade oil futures in just a few simple steps on City Index:
- Open a City Index account, or log in if you’re already a customer
- Search for ‘crude oil’ in our award-winning platform
- Choose your position and size, and your stop and limit levels
- Place the trade
Alternatively, you can practise trading oil futures first in a risk-free demo account.
Futures contracts work by speculating on the price in a future time. You can either buy or sell a contract for a commodity’s spot price with the expectation the price will rise or fall before your contract expires, allowing you to close your position and realize gains or losses from the new spot price.
Trading oil futures is like buying and selling any other futures contract. An expiration date must be determined when you initially buy long or short. Expiration dates are per month, and futures contracts end on the third Friday of the month.
Originally, futures contracts were designed to be fulfilled at their expiration date. So, you would be required to buy or sell thousands of barrels of oils. Now it’s common for traders to buy and sell their successful contracts to other companies, namely those who need the physical oil, long before the expiration date comes.
Crude oil’s volatility makes it an attractive commodity for day traders, with some brokers offering reduced margins when not holding contracts overnight. When day trading oil futures, it’s imperative to learn the fundamentals and technicals along with understanding the influence of professional traders and hedgers who dominate the oil futures market.
While major news event can cause overnight volatility, there are also frequent opportunities for price swings during the trading day as prices fluctuate at the mere hint of market news. Read more about how oil markets react to supply and demand here.
For an in depth look at how fundamentals can rapidly affect the price of oil, read our analysis of oil prices spiking due to perceived shortages in the UK as of September 2021.
Oil futures greatly affect forex as a prime export of several countries and a major import in nearly every other country. The value of a country’s currency can rise or lower significantly in reaction to the global availability of oil.
When oil prices rise, countries with an excess reserve of oil or significant production of the commodity such as the U.S. or Canada will see their currency rise in value against those of countries without significant oil reserves. Currencies with strong ties to oil exports are sometimes referred to as petrocurrencies. When the price of oil rises, these currencies tend to also rise in value, most affecting currency pairs that include only a single petrocurrency.
As the most traded commodity in the world, experienced forex traders often watch oil prices and speculate on their futures to strengthen their fundamental analysis. Read our in-depth guide to how currency pairs correlate with other assets here.
You can trade over 80 currency pairs with City Index on our…
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