Successful trading in oil futures

Traders of oil futures (financial agreements to deliver/buy oil at a specific moment in the future at a price which has been agreed upon) can also profit by participating in these spectacular financial markets. However, a lot of people try to participate without enough, or indeed any knowledge of these markets and their products - and that can lead to devastating results.

Light sweet versus heavy sour

There are many different kinds of oil, each determined by the viscosity and amount of sulphur it contains. Oil with a low viscosity number (API degree) is very treacly; this oil is called heavy. If oil has a high API degree, we refer to it as being light.

Besides the viscosity, there is the sulphur. Oil with a sulphur content of 0.5% is called sweet. An example of this is 'Sweet Bonny', the nickname for oil found in Nigeria. 'Maya oil' (Latin America) however, has a higher sulphur content of 3.5% and is therefore very sour.

Both features (sweet versus sour and light versus heavy) influence the price of oil. Light, sweet crudes (WTI, Brent) are preferred by refiners because of their low sulphur content and relatively high yields of high-value products such as gasoline, diesel fuel, heating oil and jet fuel.

Therefore this crude is more expensive than heavy, sour crudes (Maya or Arab oil). The refining process of heavy sour crude oil (Maya or Arab oil) is more difficult, or at least more time-consuming.

Correlation

It is extremely interesting that the Dubai Mercantile Exchange (a joint venture between NYMEX and Dubai Holding) is going to list Oman backed oil futures in Q4 of this year, and it is essential to be prepared.

Because of the differences in oil, there are also many differences in price, although globally all oil prices move in the same direction; maybe not to the same extent, but they do move simultaneously. Take the situation recently when Iran threatened to cut off their supply to the world: all oil prices rose. This is called correlation.

There is a (mathematical) relationship between the price of one type of oil and another and it is, therefore, possible to profit in financial markets from a certain correlation. This means that when the price of one kind of oil goes up by a certain amount, another sort (based on the mathematical calculation) is also supposed to move up by an amount relative to the price change of the first oil. If it does not, you either have to change your calculation model (or its conditions) or attempt to profit by setting up a spread.

A spread can be set up to profit from a price difference which is either too big or too small. For instance, the price difference between Brent oil and Dubai oil has been around USD 6 for the last 2 years, but at the end of 2004 this price difference was USD 14.

To profit, you have to buy the under-priced or cheap product (cheap compared to the other) and sell the over-priced product at the same time. When the difference in prices is back to its regular level (price spread is normal), you turn around the position again (close both trades). This is called arbitrage; profiting from temporary price differences.

Pair trading

When DME starts trading in oil futures, you will be able to trade spreads of future contracts based on WTI or Brent oil in combination with Oman-backed oil futures. These products and their possible substitutes are called pairs (pair trading).

Remember, however, that spreads move relatively. During the period 2002 to 2004, the average price difference between Brent and Dubai oil was around USD 2. The reason for this level was that the oil price was much lower than it is now.

Volatility

Success depends on many variables. First of all you need to become familiar with the product. Secondly you need to know about financial markets and how they operate, especially regarding the specific product you intend to trade.

What is also very important, but what cannot be learnt, is the volatility of certain markets ... and the price of oil has moved a lot over the last few years.

Products with prices that move a lot are especially suited to day trading in futures. Quickly opening (setting up) and closing a transaction is the simplest way to trade, and you can support your decisions for setting up long or short positions with all kinds of knowledge.

The most-used or obvious way to support your decisions is technical analysis (charting). The good news is that everybody can become an expert. But it is just like sport; to become really good, you have to train hard. And to become the best, you have to train extremely hard. Good luck!