What Are Oil Futures And How Do They Work
Michalis 'BIG Mike' Kotzakolios


Defined Tag: Oil Futures.

So what are these oil futures you have heard about again and again? To the novice investor (and even to experienced investors who have never traded commodities), the concept of futures can seem somewhat strange. In reality, it is quite simple: a future contract is simply an agreement to buy or sell some commodity in the future, but at a price you set today. Crude oil is not the only type of future contract you can purchase. You can also purchase contracts for lumber, metals, and even federal funds.

Futures markets allow businesses to hedge risks and to plan ahead more effectively by locking in prices that they find to be reasonable for a particular project.

Futures can also refer to the markets on which oil futures and other commodity futures are sold. It is estimated that there are more than seventy five worldwide futures trading markets. Some of these oil future trading markets include the Chicago Board of Trade (CBOT), the International Petroleum Exchange (ICE), the London Commodity Exchange, Tokyo Commodity Exchange or TOCOM, and the New York Mercantile Exchange or NYMEX. Oil future trading can be found on all these markets.

Assume an investor buys an oil future contract. This means that the investor has committed to buying a fixed amount of oil at a fixed price at a defined future date. If the price of oil rises between the time of the initial futures contract and the date of the sale, then the investor will make a profit. Conversely, if the oil's future price is lower than on the date the futures contract was created, the investor will lose money.

In essense, trading crude oil futures is a way to profit in gambling on (or forcasting) what will happen to the market price between the time you sign the contract and the time the contract has to be fullfilled. If you believe the price will go up between now and then, then you should buy, rather than sell, futures. If you believe the price will fall between now and then, then you should sell, rather than buy, futures.