The price of oil goes up, and the price of oil goes down. Sadly, when the oil price does go down there’s invariably a very long gap between that price discount reaching the pump, but that’s not what we’re talking about today! What this article is about is a very crash course into how crude oil actually gets bought and sold between traders and how the price is determined.
Supply and Demand
Just like many, if not all financial things, the price of crude oil depends on supply and demand. The last year or so has been the clearest example of this for a long time. There’s truly a glut of oil on the world market right now with a large number of oil tankers parked off shore, just waiting for the price to increase.
The reasons for this low price, in particular, is that fracking in the US has made huge amounts of oil possible to find, that wasn’t previously accessible. And this has also had the effect of turning the US into one of the largest oil producers in the world, very rapidly. But at the same time, not to lose market share, Saudi Arabia has just kept on pumping out the oil in an attempt to retain market share, even if it has had a negative effect on oil price.
So with these two factors, the amount of oil on the market has just kept on increasing. Hence a drop of over 50% in the price of oil, and it really doesn’t look as if the price is going to increase any time soon.
Calls and Puts
Oil trading options are split into calls and puts. Call option positions are taken on by traders who think that the price of crude oil will increase. This makes them bullish of course! But on the other side of the trade are investors who are bearish. These traders of course believe that crude oil prices will fall, so, they choose to place put options instead.
But whatever your trading method you’ll definitely need to do regular reviews of what’s working and what isn’t working in your investment approach, to ensure you stay on track with your goals.
Crude Oil Futures
Another approach to investing in oil is futures. These are derivative securities that give you the right to purchase oil at the price you’ve chosen. So effectively, you’re not actually buying barrels of oil as that would be hugely impractical! But you are effectively taking ownership of a percentage (very small percentage) of the world oil at the price you’ve chosen.
Then you’re betting that the price will increase and that you’ll be able to sell your crude oil future to someone else at a higher price. A simple way to think about it is it’s like investing in shares. You buy, you hold, and you hope to sell it on at a higher price.
So this has been a very crash course into crude oil trading. The simplest approach for any retail investor right now is to invest in futures, since you’re of course not taking delivery of anything, but you’ve effectively purchased oil at that price, with the assumption you’ll make a profit when you sell that future on.