The Unusual Concept Of A Crude Oil Future
Michalis 'BIG Mike' Kotzakolios


Defined Tag: Crude Oil Future.

What is the purpose of purchasing a crude oil future? Strangely, it is an attempt to improve future options for individuals or businesses trading on the commodities market who either a) want to gain from a gamble on future prices; or b) are risk averse and wish to hedge against loss and purchase crude oil at a predictable price (even if that means potentially paying more). Market participants will agree to swap rights to the commodity in the future for a price that is fixed at the time of the contract. In many cases, market participants will agree to pay a certain price one month in the future. Crude oil future contracts are particularly high in demand because oil is such a volatile commodity.

The term future might be better replaced by the terms future share or share in the future. To purchase oil futures, the investor signs a contract. The contract contains three pieces of information. The first piece of information is how many future shares the investor wants to buy. The second is the price at which the investor will buy these future shares. The third is the date on which this transaction will occur. Until that date, all the investor can do is wait to see what the results of that oil future trade will be.

On the specified date, the crude oil futures contract is opened. The investor is obligated to buy the number of crude oil shares on the contract at the price in the contract. Only then will the investor know whether the investment was a smart one! The price of crude oil when the contract is opened is compared to the price of oil when the contract was signed. If the contract price is lower than the current price, the investor can buy high priced crude oil shares for the lower price. These shares can then be sold for a profit.

The other scenario is that the crude oil futures contract is opened, and on that day the price of oil is less than when the contract was first signed. Now the investor is required to buy the designated number of oil shares at a price that is higher than the current market price. Unfortunately, if you are on the wrong side of this futures contract, you will have to purchase the shares of crude oil for a price that is actually higher than the current market value. Whether or not this risk is worth it is for you to decide.

The last scenario is considerably less exciting. In this scenario, the price of oil does not change at all. As a result, the investor will simply buy the amount of shares predicated in the futures contract; and neither side will gain or lose by having entered into the agreement. The idea of entering into such a crude oil future contract might sound strange; but at root, it is a simple gamble that the price of crude will increase between the date you enter into the contract and the future transaction.