Selling (Going Short) Crude Oil Futures to Profit from a Fall in Crude Oil Prices

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Contents

Selling (Going Short) Crude Oil Futures to Profit from a Fall in Crude Oil Prices

If you are bearish on crude oil, you can profit from a fall in crude oil price by taking up a short position in the crude oil futures market. You can do so by selling (shorting) one or more crude oil futures contracts at a futures exchange.

Example: Short Crude Oil Futures Trade

You decide to go short one near-month NYMEX Brent Crude Oil Futures contract at the price of USD 44.20/barrel. Since each Brent Crude Oil futures contract represents 1000 barrels of crude oil, the value of the contract is USD 44,200. To enter the short futures position, you have to put up an initial margin of USD 12,825.

A week later, the price of crude oil falls and correspondingly, the price of NYMEX Brent Crude Oil futures drops to USD 39.78 per barrel. Each contract is now worth only USD 39,780. So by closing out your futures position now, you can exit your short position in Brent Crude Oil Futures with a profit of USD 4,420.

Short Crude Oil Futures Strategy: Sell HIGH, Buy LOW
SELL 1000 barrels of crude oil at USD 44.20/barrel USD 44,200
BUY 1000 barrels of crude oil at USD 39.78/barrel USD 39,780
Profit USD 4,420
Investment (Initial Margin) USD 12,825
Return on Investment 34.46%

Margin Requirements & Leverage

In the examples shown above, although crude oil prices have moved by only 10%, the ROI generated is 0.00%. This leverage is made possible by the relatively low margin (approximately 29.02%) required to control a large amount of crude oil represented by each contract.

Leverage is a double edged weapon. The above examples only depict positive scenarios whereby the market is favorable towards you. If the market turn against you, you will be required to top up your account to meet the margin requirements in order for your futures position to remain open.

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Writing Puts to Purchase Stocks

If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount. [Read on. ]

What are Binary Options and How to Trade Them?

Also known as digital options, binary options belong to a special class of exotic options in which the option trader speculate purely on the direction of the underlying within a relatively short period of time. [Read on. ]

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If you are investing the Peter Lynch style, trying to predict the next multi-bagger, then you would want to find out more about LEAPS® and why I consider them to be a great option for investing in the next Microsoft®. [Read on. ]

Effect of Dividends on Option Pricing

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Bull Call Spread: An Alternative to the Covered Call

As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement. In place of holding the underlying stock in the covered call strategy, the alternative. [Read on. ]

Dividend Capture using Covered Calls

Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date. [Read on. ]

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Leverage using Calls, Not Margin Calls

To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin. [Read on. ]

Day Trading using Options

Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading. [Read on. ]

What is the Put Call Ratio and How to Use It

Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator. [Read on. ]

Understanding Put-Call Parity

Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa. [Read on. ]

Understanding the Greeks

In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions. They are known as “the greeks”. [Read on. ]

Valuing Common Stock using Discounted Cash Flow Analysis

Since the value of stock options depends on the price of the underlying stock, it is useful to calculate the fair value of the stock by using a technique known as discounted cash flow. [Read on. ]

Buying Crude Oil Call Options to Profit from a Rise in Crude Oil Prices

If you are bullish on crude oil, you can profit from a rise in crude oil price by buying (going long) crude oil call options.

Example: Long Crude Oil Call Option

You observed that the near-month NYMEX Light Sweet Crude Oil futures contract is trading at the price of USD 40.30 per barrel. A NYMEX Crude Oil call option with the same expiration month and a nearby strike price of USD 40.00 is being priced at USD 2.6900/barrel. Since each underlying NYMEX Light Sweet Crude Oil futures contract represents 1000 barrels of crude oil, the premium you need to pay to own the call option is USD 2,690.

Assuming that by option expiration day, the price of the underlying crude oil futures has risen by 15% and is now trading at USD 46.34 per barrel. At this price, your call option is now in the money.

Gain from Call Option Exercise

By exercising your call option now, you get to assume a long position in the underlying crude oil futures at the strike price of USD 40.00. This means that you get to buy the underlying crude oil at only USD 40.00/barrel on delivery day.

To take profit, you enter an offsetting short futures position in one contract of the underlying crude oil futures at the market price of USD 46.35 per barrel, resulting in a gain of USD 6.3400/barrel. Since each NYMEX Light Sweet Crude Oil call option covers 1000 barrels of crude oil, gain from the long call position is USD 6,340. Deducting the initial premium of USD 2,690 you paid to buy the call option, your net profit from the long call strategy will come to USD 3,650.

Long Crude Oil Call Option Strategy
Gain from Option Exercise = (Market Price of Underlying Futures – Option Strike Price) x Contract Size
= (USD 46.34/barrel – USD 40.00/barrel) x 1000 barrel
= USD 6,340
Investment = Initial Premium Paid
= USD 2,690
Net Profit = Gain from Option Exercise – Investment
= USD 6,340 – USD 2,690
= USD 3,650
Return on Investment = 136%

Sell-to-Close Call Option

In practice, there is often no need to exercise the call option to realise the profit. You can close out the position by selling the call option in the options market via a sell-to-close transaction. Proceeds from the option sale will also include any remaining time value if there is still some time left before the option expires.

In the example above, since the sale is performed on option expiration day, there is virtually no time value left. The amount you will receive from the crude oil option sale will be equal to it’s intrinsic value.

Learn More About Crude Oil Futures & Options Trading

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Buying Straddles into Earnings

Buying straddles is a great way to play earnings. Many a times, stock price gap up or down following the quarterly earnings report but often, the direction of the movement can be unpredictable. For instance, a sell off can occur even though the earnings report is good if investors had expected great results. [Read on. ]

Writing Puts to Purchase Stocks

If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount. [Read on. ]

What are Binary Options and How to Trade Them?

Also known as digital options, binary options belong to a special class of exotic options in which the option trader speculate purely on the direction of the underlying within a relatively short period of time. [Read on. ]

Investing in Growth Stocks using LEAPS® options

If you are investing the Peter Lynch style, trying to predict the next multi-bagger, then you would want to find out more about LEAPS® and why I consider them to be a great option for investing in the next Microsoft®. [Read on. ]

Effect of Dividends on Option Pricing

Cash dividends issued by stocks have big impact on their option prices. This is because the underlying stock price is expected to drop by the dividend amount on the ex-dividend date. [Read on. ]

Bull Call Spread: An Alternative to the Covered Call

As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement. In place of holding the underlying stock in the covered call strategy, the alternative. [Read on. ]

Dividend Capture using Covered Calls

Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date. [Read on. ]

Leverage using Calls, Not Margin Calls

To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin. [Read on. ]

Day Trading using Options

Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading. [Read on. ]

What is the Put Call Ratio and How to Use It

Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator. [Read on. ]

Understanding Put-Call Parity

Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa. [Read on. ]

Understanding the Greeks

In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions. They are known as “the greeks”. [Read on. ]

Valuing Common Stock using Discounted Cash Flow Analysis

Since the value of stock options depends on the price of the underlying stock, it is useful to calculate the fair value of the stock by using a technique known as discounted cash flow. [Read on. ]

How to Start Day Trading Crude Oil

The price of crude oil fluctuates each moment as it is traded on an exchange. The price of crude is not only determined by global supply and demand and the fundamental outlook for the physical commodity; it’s also determined by the actions of traders.

A day trader’s job is not to assess the “real” value of crude oil. Instead, a day trader profits from daily fluctuations in the price of crude, attempting to make money whether its value rises or falls.

Day trading crude oil is speculating on its short-term price movements. Physical crude oil isn’t handled or taken possession of; rather, all of the trading transactions take place electronically and only profits or losses are reflected in the trading account.

Futures Markets

There are a couple of ways to day trade crude oil. The main way is through a futures contract, which is an agreement to buy or sell something—like crude oil, gold, or wheat—at a future date for a set price. Day traders, by definition, close out all contracts each day. They make a profit or loss on each trade based on the difference between the price at which they bought or sold the contract and the price at which they later sold or bought it to close out the trade.

Crude oil futures trade through CME Group’s NYMEX exchange in New York and the International Petroleum Exchange in London. There are several types of crude oil—and associated contracts—that can be traded. The most commonly traded contracts are the West Texas Intermediate Crude Oil Futures Contract (CL), which represents 1,000 barrels of oil, and the E-mini Crude Oil Futures Contract (QM), which represents 500 barrels of oil.

On an exchange, the futures price fluctuates in $0.01 increments on the standard contract and $0.025 increments on the E-mini contract. This increment is called a tick, and it’s the smallest price movement a futures contract can make. If you buy or sell a futures contract, the number of ticks the price moves away from your entry price determines your profit or loss. To calculate your profit or loss—your trading platform will do this for you, but it’s good to understand how it works—you’ll first need to know the tick value of the contract you’re trading.

  • For the standard crude oil contract (CL), the tick value is $10. That’s because the contract represents 1,000 barrels of oil, and 1,000 x $0.01 = $10. That means for each contract, a one-tick movement will result in a profit or loss of $10. If the price moves 10 ticks, you gain or lose $100. If it moves 10 ticks and you’re trading three contracts, your profit or loss is $300. Note that crude oil can move hundreds of ticks a day, resulting in massive profits or losses in a single day of trading.
  • For an E-mini crude oil contract (QM), the tick value is $12.50. That’s because the contract represents 500 barrels of crude oil, and 500 x $0.025 = $12.50. That means for each contract, a one-tick movement will result in a profit or loss of $12.50. If it moves 10 ticks, you gain or lose $125. If it moves 10 ticks and you are holding three contracts, your profit or loss is $375.

Minimum Futures Trading Amounts and Margin Costs

The amount you need in your account to day trade a crude oil futures contract depends on your futures broker. Keep in mind that you will also need enough money in the account to accommodate for potential losses. The amount required by your broker to day trade on margin—with some of the money borrowed from your broker—varies by broker and is subject to change.

If you don’t close out all of your positions before the end of the trading day, you are subject to initial margin and maintenance margin requirements, which will necessitate still more money in your account.

Crude ETFs

Another way to day trade crude is through a fund that trades on a stock exchange, such as the United States Oil Fund (USO). If you have a stock trading account, you can trade the price movements in crude oil through such an exchange-traded fund (ETF). The value of the ETF reflects daily percentage price changes in crude.

ETFs trade like stocks. The minimum price movement is $0.01, so you make or lose $0.01 for each share you own each time the price changes by a penny. ETFs (like stocks) are typically traded in 100-share blocks called lots, so if the price moves a penny and you’re holding 100 shares, you make or lose $1. If the price moves $1, from $30 to $31, you make or lose $100 on your 100-share position. If you are holding 500 shares, you make or lose $500 on that same price move.

Minimum ETF Trading Amounts

The amount you need in your account to day trade a crude oil ETF depends on the price of the ETF, your position size, and whether you’re trading with leverage (using borrowed money). You will need at least $25,000 in your account if you’re trading in the U.S. because that is the minimum amount required by law to day trade stocks or ETFs.

Depending on how much income you want to generate and your use of leverage, you may wish to have significantly more than $25,000 available to you. At any rate, you should keep more than $25,000 in the account to cover potential losses that would make the account’s value fall below that minimum amount.

The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    Best Binary Options Broker!
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    Binomo

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