In my effort to learn everything humanly possible about trading oil, I have put together this “guide” on trading oil options contracts. The page is updated regularly.
Oil is presently the largest commodity traded, and as such, holds strategic importance in modern economies. Without it, modern life would not be as it is.
Here are the main factors that affect the price of oil:
- Supply and demand – Being a commodity, and one of the most important ones in the world for that matter, the price of oil is determined based on global supply & demand. I’ll talk more about this below.
- The USD – Since oil is quoted in US dollars, the price of the USD directly affects the oil purchasing power of countries. 2 things happen if the USD appreciates. Firstly, oil becomes more expensive for everyone outside the US, lowering demand. Secondly, oil producers get more local currency for a barrel of oil, making their profits less susceptible to lower oil prices, meaning they can pump more oil even at lower prices. But what happens when they supply more oil? Higher supply, lower prices.
- News, market sentiment, speculation – In general, market sentiment will reflect global demand, but keep in mind that speculators trade on rumor, not fact. Despite all the fundamentals that may seem sound, anything can happen.
Of course, there are many other factors that affect the price of crude, for example:
- The weather (hurricanes damaging oil rigs, ports, pipelines would lower supply, while hurricanes affecting refineries would lower demand). The EIA maintains a real time map of energy disruptions here.
- Geopolitical risk. Wars or terrorist attacks in oil producing territories will cause higher oil prices.
Suppliers of Oil
There are 3 main powers that supply oil, and thus, affect prices:
- North America – USA strives for energy independence via growing oil production and Canada (net exporter of oil)
- OPEC, which is basically a price cartel of member countries
- Russia and the Commonwealth of Independent States
Out of the above, only the North American (USA and Canada) suppliers are not “Petro states”. The income of all of the other countries is grossly determined by their sales of oil, ranging from 30-90% of national income.
Demand for Oil
Global demand can be split into 3 main regions:
- USA – Largest producer and user of oil in the world. Existing demand and economic data that might affect demand from the US is watched very carefully, as it has a direct impact on world demand, therefore prices.
- Europe – With the exception of Norway, all of Europe is an importer of oil. Being modern economies with little output of oil, European demand influences prices second in strength to the USA. If the EU shows signs of growth, oil demand increases, and vice-versa.
- China – Growth in China has been pushing new demand for oil for over a decade. Slower industrial growth in China, and a move towards a service centered economy means lower oil demand growth.
With that said, India could be the next China as their standards of living gets better, and their consumption starts growing to Western levels.
Data to watch for trading oil
- American Petroleum Institute (API) weekly report – published every Tuesday afternoon after market close (or Wednesday, if Monday was a holiday)
- US Energy Information Administration (EIA) weekly report – published every Wednesday 10:30 eastern time (link to the summary and the link to the detailed reports), keeping track of US oil stockpiles. The main movers of the market from this report are:
- the crude stockpile builds/draws
- the change in daily crude production (here is the historical production data, but the Wednesday 10:30 Excel report shows this sooner)
- refinery usage,
- gasoline stockpiles
- Baker Hughes rig count – most importantly North American oil rig count released at 13:00 eastern time on the last workday of the week (link)
- OPEC meetings – where they set production for OPEC member countries
- OPEC monthly reports – Long, but insightful (link). They also have a podcast of each report.
- International Energy Agency (IEA) reports – Paris based organization (link)
- Reports of independent companies measuring real storage facility supplies
- Macroeconomic reports of major consumer countries (USA, Europe, China)
- Term structure of oil, watch for movements into contango or backwardation (link)
Oil instruments
There are 2 major classifications of oil which you’re likely to encounter during your trading career:
- Brent Crude – futures symbol /BZ
- Brent Crude Oil is the benchmark for oil prices in the EMEA region (Europe, Middle East, Africa)
- Extracted by 15 oil fields located in the East Shetland Basin in the North Sea
- Worldwide export
- Traded on ICE (Intercontinental Exchange) in London, a deliverable contract based on EFP delivery with an option to cash settle
- West Texas Intermediate (WTI) – futures symbol /CL
- WTI Crude Oil is the benchmark for oil prices in the United States
- Extracted in the US and delivered at the Cushing in Oklahoma
- USA consumption only
- A commodity of New York Merchantile Exchange, traded as futures contracts
There are also smaller classifications, but these aren’t that important for trading today: Dubai Crude, Oman Crude, Urals oil and the OPEC Reference Basket.
If you were to trade oil futures contracts, the above is all you would need.
If you want to widen your possibilities, and trade options on oil futures contracts, read on.
Trading oil options
I have found that the oil options with the best liquidity are:
- /CL – Options on the actual WTI crude futures contracts
- Expiry of options not uniform, here are the expiration dates
- USO – An ETF call United States Oil Fund, which follows /CL very closely
- Expiry on 3rd Friday of each month, as with all equities