Futures contracts are a broad concept whose use is not limited to any particular field as it can cut across virtually every aspect of investment that involves trading in one way or the other. A futures contract is a legal agreement like every other contract which specifies the sale of oil in the future between a willing buyer and seller at a particular price and a predetermined period. Futures contracts specify the quality and quantity of oil which has been agreed upon by the interested parties. In this section, the buyer is obligated to buy at a particular price or sell at a particular price regardless of what the market forces are dictating at that period.
Futures contracts have similarities with other parts of the financial world. One of these is forwards which are generally just an agreement to buy or sell oil at a future date. The only differentiating factor between the two concepts is that forward trades are executed over the counter and the terms can be modified provided that the involved parties are satisfied. This is the opposite of the futures contract case which will have the same terms regardless of the counterparty.
Mechanisms of future contracts.
The mechanisms of the futures contracts operations are quite open to any interested party. In the oil sector, trading with the Oil Profit is the major goal of any investor. picture an oil producer with the intent of producing a million barrels of oil over the coming year. Taking the price of oil to be $75 per barrel, and the produced barrels will be ready for delivery in about 12 months. The producer is faced with the options of producing the oil and selling it at the going rate when it’s ready for delivery in a year. However, the oil market is one of the most volatile markets as such, the variations in future prices can be intense. Even though the potential for an increased price exists and is promising, the case could turn out to also be the opposite, with prices plummeting down the drain. This risk is what has been curbed to an extent through the creation of futures contracts.
In the determination of future oil prices, there are mathematical models which are usually employed to that end. These models take into account several factors that could have different effects on the varying price levels. Some of these factors include the maturity period, the spot price, costs of preservation, risk-free rate of return, and convenience/dividend yields. The conveniences that come with entering into a futures contract are beneficial for both parties as the seller is insulated from losing money and so is the buyer.
Trading oil futures.
In most cases, then retailers that buy these large amounts of oil at specific contract prices are investors trying to get an edge on the future change in the price of oil. While trading, futures contracts can also be traded with the single goal of making a profit from the market. The only clause for executing these trades is their closure before they get expired. There are variations between the prices of oil throughout the trading period leading to different profit and loss positions. However, there are cases where the loss can be far too phenomenal and in such cases, the trader will be required to invest more money to cover his current level of loss. This is usually known as the maintenance margin.
Trading oil carries substantial risks just like every marketplace, there are possibilities for profit or losses. However, there are always loopholes traders explore to stay three steps ahead of the market and trading oil futures is one of the easiest ways.