Oil Futures Contracts Make a Sound Investment
April 2, 2009 by Nigel Evans
Filed under Stock Exchange
Oil futures contracts are a solid investment, because they give you a variety of options with good risk management strategy. Of all the commodities, light sweet crude oil, commonly used for heating, jet fuel, diesel fuel and gasoline is the most popular around the world. It is 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.
The unit of measure for an oil futures contract is a barrel. Typically, this will involve a variety of grades, consumed both internationally and in the USA. A typical contract equals 1000 barrels of oil, but for investment portfolio purposes, the agreement dictates 500 barrels of crude oil, and which is half the size of a typical futures contract.
There are two major exchanges for oil futures contracts — the New York Mercantile exchange and the Intercontinental exchange. Trading may relate to delivery taking place several years from now, but typically relate to delivery in three months.
Oil futures contracts exist in many forms. A short hedge contract allows investors to buy futures to sell oil, whereas a long hedge contract allows investors to buy futures to buy oil. It is usual to find a mix of both in a portfolio. For a number of years, there has been increased interest in oil as it is considered a better option to stocks.
Oil futures contracts are used most often in the risk management of portfolios. As investors buy and sell a security, they purchase or sell a future security with the opposite risk. This means that losses and gains balance each other and balance the risk in the portfolio between current and future market rates. If a portfolio is balanced there is less risk for 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.
Investors who hope to make a profit based on future prices will often speculate with oil futures contracts. Banks and other financial institutions generally make up the majority of speculators and are thus important to the trading market.
