Oil derivatives are contracts based on crude oil that allow for trading, buying, and selling of oil-related activity. They provide tools for risk management and investment opportunities, but require knowledge and skill to make intelligent market projections. Trading derivatives can be risky and is usually done by advanced investors or special funds.
Oil derivatives are financial instruments that use oil, usually crude oil, as an underlying asset. The derivative has no inherent value and is just a contract for oil-related activity, but people can trade, sell, and buy derivatives to access the value of the oil used as the basis of the contract. Such contracts have been a part of financial markets since the 19th century and provide producers of various products with a number of useful tools for conducting business. Companies can use petroleum derivatives to spread and reduce risk, as well as to address problems such as not wanting to store oil for long periods of time.
The most basic oil derivative is a futures contract. When people draw up the contract, one party agrees to buy a fixed amount of oil at a certain price at a future date. Another form is an options contract, where people have the option to make a purchase on a particular date, and can then decide if they want to exercise it. Petroleum derivatives allow people to manage risk; For example, a futures contract can help people avoid temporary volatility in oil prices and get oil at a guaranteed price. Options can provide hedging, creating the opportunity to buy below or sell above the market price, depending on the contract structure.
While petroleum derivatives were initially developed for use by the oil industry, they may be traded by other investors. In many cases, people who trade derivatives have no plans to receive the underlying asset; a Wall Street investor has absolutely no interest in a tanker worth of oil, but does want to take advantage of changes in oil prices to profit from oil derivatives. These contracts provide a mechanism to invest in commodity trading. People can also buy and sell stocks and bonds issued by oil companies.
Trading petroleum derivatives requires knowledge of the industry, skill, and the ability to make intelligent market projections. People rely on many types of data to make investment decisions. The news can provide information about possible future changes in oil prices, and people also pay attention to political events, oil policy, and issues such as consumer demand. Knowing, for example, that the demand for oil tends to increase in the summer, people can plan their investment activities accordingly.
Derivatives trading is usually the province of advanced investors or special funds. It can be risky, especially on large volumes and in a volatile market. Even qualified investors can make mistakes when predicting future financial movements, and this can result in costly losses.
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