Tuesday, June 15, 2021
Crude oil day traders blog


How to trade crude oil futures?

The quintessential guide to trading crude oil futures. Read this detailed guide before you start trading crude oil futures.

By OilTrader , in Trading Basics , at May 25, 2021 Tags: crude oil futures, crude oil futures contracts, crude oil futures exchanges

This is probably the only guide you need to read on how to trade crude oil futures online. This guide is made for the absolute beginner. So do not worry if you have never traded in oil futures. We cover all aspects from the very basics to everything that you should know about oil trading.

Crude oil futures, as the name indicates are futures contracts on crude oil commodity. Obvious from the term futures, this is a derivative product. A financial derivative is an speculative or a hedging instrument. They are called derivatives because the price of these instruments are derived from an underlying asset. In the case of crude oil futures, the underlying asset is obviously crude oil.

Derivatives, such as futures are also used for speculative purposes. So when you want to trade crude oil futures, you will most likely fall into the “speculator” category. What this means for you is that, when trading oil futures, you simply bet on whether oil prices will rise or fall. It is interesting to note that speculators in the futures markets are only a minority.

The oil futures markets are largely dominated by two big groups. The producers and the consumers.

Producers in the oil markets are obviously the oil companies that have drilled crude oil and want to market it further downstream. Read the basics of crude oil here to get an idea of how this commodity market works.

As I mentioned in the article, there are different ways to trade crude oil. Oil futures are one of the many ways you can get an exposure to the oil markets.

What are you trading with crude oil futures?

We will start by addressing the most obvious question. What are you trading, when you trade crude oil futures?

It should be easy to answer this question. When you trade crude oil futures, you are trading the raw material, the crude oil or the black gold that is extracted from the sea bed or from underground on land.

Remember that crude oil futures trading is speculating on the raw crude oil price

Many wanna-be crude oil traders make this mistake. Ask them what are they trading and the answer can be as varied as the crude oil itself to petrol or diesel or gas. As I mentioned, the raw crude oil can be used to create many other oil based products.

So, to put this succinctly, crude oil futures trading is all about speculating on the raw material. From here on, the crude oil can be converted into a diverse range of products.

If you think of yourself as an oil refinery, then obviously you will need to purchase crude oil. This is unless you also own the oil drilling and exploration company too. But in most cases, oil refineries are different from oil drilling companies.

So, as an oil refinery, you buy crude oil and then you refine it into different products like lubricants, petrol, diesel, kerosine and so on.

Definition of crude oil futures

Crude oil futures are derivative contracts. It allows the buyer and the seller to enter into a contract, a financial obligation of sorts. This contract allows the buyer to buy a certain number of crude oil barrels, for delivery at a future date.

The price at which you buy is set at the time of entering the contract. When the oil futures contract expires, you are given the delivery of the underlying asset, which is the crude oil barrels.

An easy way to understand this is to think of yourself pre-ordering a new iPhone. You pay for the phone now, and it is delivered to you in a month or a few week’s time. It doesn’t matter if the cost of the iPhone suddenly increased or decreased.

As you can see from this example, you are obviously making a profit if the iPhone price increased within the month of delivery. On the contrary, you would lose money if the cost of the iPhone decreased during the month.

Crude oil futures work the same way!

Where are crude oil futures traded?

Crude oil futures, as mentioned are futures or derivatives contract. To be more specific, futures are cleared derivative instruments. A cleared derivative instrument is one that is cleared and settled on an exchange. In this case, it is the futures trading exchange.

A futures trading exchange is similar to a stock exchange where stocks or equity is traded.

The difference being that in a futures trading exchange, only futures contracts are traded. There are many different futures contracts, starting from financial futures like currencies, interest rates to commodities such as grains, metals and energy futures where crude oil belongs to. Some of the most well known oil futures trading exchanges include CME Group. The Chicago Mercantile Exchange is one of the well established and popular futures trading exchange.

The CME NYMEX oil futures are well known in the markets. In fact if you are trading crude oil futures, you are most likely trading the WTI crude oil futures. Read more details about the CME oil futures here. You can also trade the Brent crude oil futures.

Besides the CME group, we also have ICE. Known as the Intercontinental Exchange, ICE is also a well established futures exchange. It is also widely used internationally because CME group is mostly concentrated for the American markets. The main difference is the difference in the ticker. ICE exchange use the ticker T, whereas CME group uses the ticker CL for WTI crude oil.

How does a crude oil futures broker fit in?

When you are trading crude oil futures, it is very likely that you will be trading via a futures broker. This futures broker is not the exchange, but a broker or an intermediary. You, as an individual cannot directly have access to a futures trading exchange. You need to buy a membership first which is very expensive as an individual. Therefore, a futures broker comes into the picture.

The futures broker acts as an intermediary and allows you access to trade. When you place your oil futures trading orders, the broker can pass it along to the exchange. However, take this with a pinch of salt. The average futures contract order an individual makes is very small comparing to the other big players.

Therefore, your futures broker can either match your orders within their customers, or aggregate all the orders and execute it as a single block order.

How to trade Crude Oil Futures – Contracts order flow

The above picture gives a visual illustration on how the retail orders are passed on to the exchange. But now, you might ask the question of what happens when you hold a futures contract to delivery? According to logic, you should be getting delivery of the crude oil barrels isn’t it?

Well, to prevent this from even accidentally happening, your futures broker will either roll-over the contract upon expiry or close out your order. Whichever is more convenient!

Crude oil futures ticker anatomy

When you trade oil futures, you will certainly come across some technical terms and jargon. In this section, we will explain everything, including how to read a crude oil futures contract.

A crude oil futures contract has a ticker or a symbol, just like a stock market ticker. But, unlike stock market ticker names, which are abbreviations of the company, in the futures market, the futures ticker is different.

The concept of futures tickers for crude oil is as follows.

<Commodity Symbol><Expiry Month><Year>

Commodity Symbol for crude oil is CL (CME Group) or T (ICE Exchange) for WTI crude oil.

Because crude oil futures expire on a month to month basis, every month has a symbol. This is nothing but a bunch of letters.

This is also known as the futures contract month code. The table below gives an idea of how the contract months are denoted.

Futures Expiry Month Month Code
January F
February G
March H
April J
May K
June M
July N
August Q
September U
October V
November X
December Z

So if you are trading an April futures contract, using the above information, the oil futures ticker will be CLJ. But ticker should be unique. In order to make this unique, we then add the last digit of the year. For the April 2021 Crude oil Futures contract, the ticker will now be CLJ1. Or if you were to trade this same commodity on ICE exchange, the ticker would be TJ1.

And in the next year, for a June 2022 oil futures contract, the ticker will be CLN2. This is easy to understand and using the table above you can easily understand what the futures ticker will be like. Just remember that the first two characters ‘CL’ are important as it denotes the commodity you are trading in futures.

Crude oil futures contract specifications

It is important that you know the contract specifications for oil futures. Obviously, a one contract size in grains is not the same as one contract size in oil futures. Below table outlines the oil futures contract specifications at the CME group.

Contract Unit 1,000 barrels
Price Quotation U.S. dollars and cents per barrel
Trading Hours Sunday – Friday 6:00 p.m. – 5:00 p.m. (5:00 p.m. – 4:00 p.m. CT) with a 60-minute break each day beginning at 5:00 p.m. (4:00 p.m. CT)
Minimum Price Fluctuation 0.01 per barrel = $10.00
Product Code CME Globex: WS
CME ClearPort: WS
Clearing: WS
Listed Contracts Monthly contracts listed for the current year and the next 5 calendar years and Jun and Dec contract months for 3 additional years. Add consecutive monthly contracts for a new calendar year and additional Jun and Dec contract months following the termination of trading in the December contract of the current year.
Settlement Method Financially Settled
Floating Price The Floating Price is equal to the NYMEX Light Sweet Crude Oil Futures 1st nearby contract settlement price on the penultimate trading day for the delivery month.
Termination Of Trading Trading terminates 4 business days prior to the 25th calendar day of the month prior to the contract month (1 business day prior to the termination of trading in Light Sweet Crude Oil Futures).

How are oil futures contract settled?

Oil futures contracts can be settled in two ways.

Cash settled or financially settled: In a cash settled futures contract, the contract is closed and the difference between the futures price which you bought and the spot price upon expiry is settled. If you are in profit, you are paid out, and if you are in loss, you have to pay. The profit and loss is automatically handled by your futures trading broker. Most of the futures contracts that you trade online are settled for cash.

Physical delivery: As the name suggests, physical delivery happens when you want to take delivery or you want to offload your inventory. Physically settled oil futures contracts are used only by large companies. Therefore, as a retail oil futures trader, you do not have to worry about this.

How to trade Crude oil futures – Frequently Asked Questions

Below is a list of most frequently asked questions when it comes to trading crude oil futures.

What is the futures expiry month

The futures expiry month is the month for which the contract expires and is delivered. Typically, a futures contract expires on the third Wednesday of the month. This is so as to ensure that there is enough time (at least a week) for the settlement or delivery to take place.

Does it matter which futures exchange you trade crude oil at?

Yes it certainly does. Different futures exchanges have different contract specifications. Therefore, make sure that you fully understand where your futures broker is executing the orders. Of course, you can already see this information through the futures broker’s trading platform.

How many oil futures contracts are available for trading?

Technically, you can trade any oil futures contracts, up to six months or even longer. However, the further out you go, the less liquid they become. Therefore, there is a considerable risk of large price movements on further dated oil futures contracts.

How often do oil futures contracts expire?

Oil futures contracts expire on a monthly basis. Therefore, you should close out your position before the expiry date or risk having your position closed or rolled over by your futures broker.

What is a roll over in oil futures?

A roll over simply means that your contract is rolled over into the next available contract. A roll over happens prior to the expiry. Oil traders can roll over their contract into the next month, which is done by automatically closing your current contract and opening a new position in the next active contract. Roll over is done automatically by your futures trading broker.

Trading crude oil futures – Summary & Recap

To summarize, the above points give you all the information you need to learn how to trade crude oil futures. As a trader, it is in your best interests to learn about the commodity that you want to trade. The information provided in this oil futures trading guide should give you enough to get started. Remember that trading oil futures is risky and you can lose your invested capital.

As with all financial and derivatives trading, remember to invest carefully.

Comments


Leave a Reply


Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.

Exit mobile version