Although the world is making an attempt to turn to renewable energy sources, in 2020 fossil fuels still made up 84% of the world’s energy supply. One such fossil fuel that we still rely heavily upon is oil.
Crude oil makes the world go round, almost literally, because it’s used in the production of many of the essential fuels that are used to power our vehicles. This includes diesel, gasoline and jet fuel. Since crude oil is a light and sweet grade, it is favoured for these products, because refining it is relatively cheap and easy.
In terms of trading, the oil market is subject to high volatility levels. Prices are easily influenced by external factors and can often fluctuate. This can put you at risk of making losses on your capital, however, short-term price changes can also generate a potential for profits.
As such, it’s vital that you do your research and are familiar with technical analysis, to help you to make informed decisions with regards to the positions that you take. If you’re looking to open a position in the oil market, you’ll need to familiarise yourself with oil futures and options.
So, to get you started, we’ll explain what these are and why they’re important when trading oil.
Crude oil futures
At a basic level, futures are a contract that is put in place for a future transaction. A futures contract is an agreement between the producer and the refinery that the transaction will take place at a later date at a rate that has been confirmed by both parties.
Futures contracts allow refineries, for example, to lock in prices with oil producers and have their delivery arranged for a date in the future. This price is set, and will not change, no matter what the price of oil is trading at when the transaction date arrives.
When oil is bought by wholesale producers, they need to know the price of the raw material in advance, to confirm the price of resulting products to the consumer. Without knowing this, they would not be able to effectively manage their expenses and predict costs.
Crude oil options
Similar to futures, options are contracts that allow the contract holder to choose when they purchase the commodity, and consists of a future date and an agreed rate. The main difference between a futures contract and an options contract, is that there is no commitment to buy, giving you flexibility — hence the name.
For example, should a refinery sign an options contract with a producer, they will come to an agreement based upon the condition that the refinery pays a deposit upfront. This safeguards the producer should the transaction fall through.
One of the key benefits of an options contract is that it provides traders with the ability to act upon market prices prior to the contract expiring. For example, if a better oil price is found before the transaction date, they can allow the contract to expire and purchase the barrels at the reduced rate.
You can also use a contract for difference (CFD) when trading oil, and this can be highly advantageous. A CFD is a deal between an investment broker and an investor, whereby they agree to exchange the difference in value of crude oil, as an example asset, once the contract has ended. When oil trading on Plus500, an online CFD trading platform, you can speculate on the price of oil and exercise fundamental analysis to make informed market predictions.
It can be beneficial to trade oil options CFDs in particular, because it enables you to trade on the movement of crude oil without opening a position on the value of the commodity. You are trading on the value of the options contract, rather than on the underlying asset itself.
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