Futures markets allow investors to buy a set quantity of a commodity at a fixed price on a future date. Oil, corn, and gold are the largest futures markets. Hedgers and speculators are involved in oil futures, with hedgers using both the spot and futures markets 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 specified quantity 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 had spread to Europe and the Americas. The first futures markets originated out of necessity, with sellers having to hedge large swings in the price of their product, gaining assurance from buyers that, no matter what the market looked like, within months they could get the price they needed. need it.
Oil futures are one of the largest futures markets, along with corn and gold. They account for billions of United States Dollars (USD) in trade each day and help determine the price of oil at the consumer end. Oil futures can be a little confusing for some people, as it seems odd that an investor would want to buy large quantities of something like oil, but it’s precisely because they don’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. Hedges are people who actually want to buy and sell oil, the physical commodity. These hedgers want to move within the product, but they want to minimize the risk they might face based on market fluctuations. Speculators, on the other hand, don’t want to own the oil at all, but they do want to take a bit of a risk and possibly make some serious money. So they buy oil futures contracts, off the hedges, based on what they think the price of oil will be.
Oil futures can be hedged short or long. A speculator who buys short-hedged oil futures is buying a contract in the future by saying that he will sell a certain amount of oil at a certain price. A speculator will profit from short hedging if oil prices fall. A speculator buying long oil futures hedge is buying a contract to buy a certain amount of oil at a certain price. This speculator will profit if oil prices rise.
The way hedgers ensure they are safe no matter what happens in the market is by exploiting both the spot market and the oil futures market. The spot market is the money market, based on the daily price of oil, and by taking an opposite position in the spot market from what they take in the futures market, they ensure that no matter which direction the market goes, they close neutral.
Speculators only buy oil futures – they never buy in the spot market – so they are not hedging their purchases to stay 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 measure market movement incorrectly, they can lose just as drastically.
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