Futures markets allow investors to buy a set amount of a commodity at a set price on a future date. Oil futures are a major market, with hedgers and speculators involved. Hedgers use the spot market and futures market to minimize risk, while speculators bet on market movement to make a profit.
Futures markets are commodity markets where investors essentially agree to buy a set amount of some commodity at a set price at a future date. Futures markets originated in early 18th century Japan, and by the early 19th century they had spread across Europe and the Americas. Early futures markets arose out of necessity, with sellers needing to hedge against large swings in the price of their product by getting reassurance from buyers that whatever the market looked like in a few months, they could get the price they needed. this.
Oil futures are one of the biggest futures markets, along with corn and gold. They account for billions of US dollars in exchange every day and help drive the end-consumer price of oil. Oil futures can be a little confusing for some people, as it seems strange that an investor would want to buy large amounts of something like oil, but it is precisely because he doesn’t want to actually own the physical oil that the oil futures market works.
There are basically two groups of people involved in oil futures: hedgers and speculators. Hedgers are people who really want to buy and sell oil, the physical commodity. These hedgers want to move around the product, but they want to minimize the risk they might encounter based on market fluctuations. Speculators, on the other hand, don’t want to own the oil, but they do want to take a little risk and possibly make a lot of money. So they buy oil futures contracts from hedgers based on what they think the price of oil will be.
Oil futures contracts can be short or long hedged. A speculator who buys a short oil futures hedge is buying a futures contract, saying he will sell a certain amount of oil at a certain price. A speculator will profit from a short hedge if oil prices fall. A speculator who buys a long hedge of oil futures is buying a contract to buy a certain amount of oil at a certain price. That speculator will make a profit if oil prices rise.
The way hedgers ensure their safety no matter what happens in the market is by leveraging the spot market and the oil futures market. The spot market is the spot market, based on the daily price of oil, and by taking an opposite position in the spot market than they take in the futures market, they ensure that regardless of the direction of the market, they end up neutral.
Speculators only buy oil futures – they never buy in the spot market – so they are not hedging their purchases to remain neutral. Instead, they are betting that the market will move up or down and that they will profit from that turn. If they are correct, they can make large amounts of money in relatively short periods of time, but if they misjudge market movement, they can lose just as drastically.
Asset Smart.
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