Furry
WoW Office
- 19,680
- 24,925
I did something rare for me and waffled today when the oil stuff started going down, back nearly 100% cash until I better understand the implications. I've never paid much attention to commodities. The credit market is pretty much a trash fire still that isn't showing signs of improving no matter how sayan the fed goes with money, and I don't like two contagions. Ended up back where I started, and heres a run down of how oil markets work.
1. Oil producers have brokers that sell contracts to buyers for future pickup days. At this time, a contract price is agreed upon.
2. Once these future contracts are bought, they can be traded similar to options. Their value can change, but the contract price does not change.
3. On the date specified in the contract, the owner becomes locked in and becomes responsible to pay the contract price to get the oil.
The major difference between these contracts and options is part 3. The person holding the contract at the end must buy the oil for the price specified at the time the contract was made. Reading various versions of contracts for oil, there's a few things worth mentioning. There's a 10% wiggle room in value of delivery that is mandatory to accept. Order 100 barrels, and you have to buy 90 or 110 if either shows up. This gives a little leniancy for failed contracts. Additionally, brokers can optionally allow you to, at their discretion, pay a fee and the difference in cost to accept delivery at a later date. Also, there is usually about a month window in which you can accept delivery via the methods acceptable to the contract, usually limited to pipes connected to their system or berths at ports.
The wiggle room allows both sides to deal with problems on a small scale and be more forgiving to a small % of failed contracts in normal times, but in these times, a failed contract probably will NOT be allowed to escape with the typical fee. After that point, the contract becomes not just worthless, but a liability if you aren't planning on picking up that oil. You are responsible for moving it out, and must often pay things like storage fees, you owe the money in the contract anyways, and that money you don't pay collects interest.
At least that's how I understand it after a few hours of research, and I definitely glossed over some stuff. Someone can feel free to correct me if I got something wrong.
1. Oil producers have brokers that sell contracts to buyers for future pickup days. At this time, a contract price is agreed upon.
2. Once these future contracts are bought, they can be traded similar to options. Their value can change, but the contract price does not change.
3. On the date specified in the contract, the owner becomes locked in and becomes responsible to pay the contract price to get the oil.
The major difference between these contracts and options is part 3. The person holding the contract at the end must buy the oil for the price specified at the time the contract was made. Reading various versions of contracts for oil, there's a few things worth mentioning. There's a 10% wiggle room in value of delivery that is mandatory to accept. Order 100 barrels, and you have to buy 90 or 110 if either shows up. This gives a little leniancy for failed contracts. Additionally, brokers can optionally allow you to, at their discretion, pay a fee and the difference in cost to accept delivery at a later date. Also, there is usually about a month window in which you can accept delivery via the methods acceptable to the contract, usually limited to pipes connected to their system or berths at ports.
The wiggle room allows both sides to deal with problems on a small scale and be more forgiving to a small % of failed contracts in normal times, but in these times, a failed contract probably will NOT be allowed to escape with the typical fee. After that point, the contract becomes not just worthless, but a liability if you aren't planning on picking up that oil. You are responsible for moving it out, and must often pay things like storage fees, you owe the money in the contract anyways, and that money you don't pay collects interest.
At least that's how I understand it after a few hours of research, and I definitely glossed over some stuff. Someone can feel free to correct me if I got something wrong.
