Oil futures contracts represent a sound investment, as they carry a variety of options and good risk management alternatives. Amongst the commodities, light sweet crude oil, which is commonly used in heating, diesel, jet fuel and gasoline is the most commonly traded.
Oil futures contracts carry a legally binding agreement to purchase or sell a set amount of oil at a predetermined price. This price is projected and based on supply and demand. The price of oil fluctuates daily in a volatile market. Investors have the option of settling for cash or arranging for the delivery of actual oil to a set location.
With oil futures contracts, trading is done in units of barrels and generally includes a number of grades for use both in the United States and internationally. The standard contract is 1,000 barrels of oil. For investment portfolios, the contract is typically 500 barrels of crude oil, which is half the size of a usual futures contract.
Major exchanges for oil futures contracts include the new New York Mercantile exchange and the Intercontinental exchange. Whilst trading typically relates to delivery in three months time, it could specify several years in the future.
There are several types of oil futures contracts. With a short hedge contract, investors buy futures to sell oil. In a long hedge agreement, investors buy futures to buy oil. Generally, a portfolio would include a mix of both. For several years, there has been increased interest in oil among investors who consider them a viable option to stocks and bonds.
Oil futures contracts are often used in risk management of portfolios. Investors, by buying or selling a security, purchase or sell a future security with the opposite risk. In this way losses and gains counterbalance each other and also balance the risk in a portfolio between current and future market prices. It goes without saying that a more balanced a portfolio, the less risk there is for a major loss.
Oil futures contracts are commonly used for hedging, most especially amongst businesses that make products or offer services that use oil, in particular utility companies and airlines. Whilst it is difficult to set a price for these products or services buying or selling futures contracts in this way helps to reduce the risk and overcome the constant fluctuations in pricing.
Oil futures contracts are often used for speculation, where investors hope to make a profit based on future prices of the commodity increasing or decreasing. Financial institutions, including banks, generally make up the major portion of speculators and are an important piece to the trading market.
Tags: Commodities, Finance, oil trading, stock exchange