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Crude Oil Futures

The one area of oil futures trading that always seems to create more confusion than any other is the issue of rollover and for those of you who already trade oil futures and options will know that oil trading increases in volatility the closer to settlement day. This is due to the number of contracts being “rolled over” or expiring. OTC (over the counter) contracts are based on the ICE futures prices front spot month, (which simply means the current month’s contract) as this futures oil price is the largest price benchmark for the oil industry worldwide. The easiest way to understand rollover is to consider some examples to see how it works in practice.

In order to remove final day volatility from OTC contracts some brokers switch from using the front month into the second month one oil trading day prior to expiry, in other words the day before it expires. NB If you are new to futures trading and confused about rollover completely and the reason for it, please visit my futures trading site and start there. However, a quick explanation – all futures contracts have an expiry date – it is part of the contract specification. So let’s look at some typical futures oil trading contracts, starting with Brent crude contracts to understand how this works:

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Let’s assume we are trading a mini Brent crude oil futures contract for September, which is due to expire on the 14th of the month. On the 13th, the contract would be rolled forward into October. Now clearly there is a price difference (which could be higher or lower depending on market conditions). In this case the October contract is higher by $114.85 – $113.47 = $1.38, but this is obviously not a price rise in oil, but simply a move of the contract to a new reference price, and therefore no profit or loss will be incurred as a result. So how does this work in practice. Let’s take two examples as follows :

Example One :

  • Long position – One OTC September crude oil future contract of 1000 barrels at $113.47
  • A cash adjustment of -$1,380 is made on the account
  • A “profit” of $1,380 is made on the open position
  • The net financial position is zero and we are now trading the October rolled over contract

The second example is a short position using two contracts and with the same expiry date as above.

Example Two :

  • Short position – Two OTC September crude oil futures contracts of 2000 barrels at $113.47
  • A cash adjustment of +$2,760 is made on the account
  • A “loss” of -$2,760 is incurred on the open position
  • The net financial position is again zero.

What is important to understand is that when the trading oil price is rolled from one month to the next, this is booked at the official futures settlement price on the exchange i.e.- $1.38. Every other oil trader in the market would need to pay the spread which would be a cost of anything up to 10 cents ($1.33 – $1.43).