I am a bit confused about futures pricing formula in relation to the negative oil futures price we saw in May 2020 contract. Futures Price = Spot + Cost (to hold spot) - Yield (from holding spot) Cost = borrowing in risk free rate, storage cost for commodities Yield = convenience yield for commodities, dividends from stocks For oil futures F = Oil Price + Storage Cost - Convenience Yield If Storage Cost > 0 and Oil Price > 0, shouldn't Oil Future Price be positive, how can it be negative?
Negative Crude Oil Prices?? It is perhaps even more confusing than seeing negative interest rates to see negative oil prices. Both occurrences are quite rare, and there isn’t a lot of information out there explaining it, so let us attempt to clarify where negative pricing comes from and why. Futures contracts are where oil is primarily traded. In a futures contract, an oil producer agrees to deliver a certain amount to an oil user. For example, Exxon, an oil producer, may agree to produce and distribute 3,000 barrels to Boeing, an oil user. Once the contract is made, it is traded on the futures floor, the price of oil fluctuates, and eventually the last person holding the contract when it expires owns the 3,000 barrels ( 3 contracts of 1000 barrels each). However, most people who trade oil futures are not oil users. So often, a trader who owns a contract that is about to expire will “roll the contract”, or sell it to an actual oil user. On April 21st, 2020, the last day to roll MAY oil contracts, traders tried to sell these contracts, but for the first time in history, no one was buying. All oil users already had enough oil, so traders had to resort to giving the contracts away, and when even that did not work, the offered to pay these users to take the contracts off their hands, and thus, the negative oil price occurred. A big reason oil users were not buying at any price was that their oil storage facilities were filled up. As a result, oil producers were forced to slow production, which actually costs them more money. So when the oil price dropped as low as negative $37 a barrel, it wasn’t that a negative amount of oil was produced, it was that no one wanted the oil that was already there. Also we got MANY calls of clients thinking they can “buy oil at negative prices”, when crude oil or any other deliverable commodity gets into last trading days/ first notice days time frame, the only clients who should still be in there are pre qualified hedgers/ qualified traders who are ALREADY set up and well capitalized to either take delivery or provide delivery….. From what I understand, a lot of this has to do with an OIL ETF that got flooded with “clients who thought oil prices were too low”….but this is a topic for another discussion. Also in regards to Crude Oil futures – if you are actively trading this market, visit: https://www.cmegroup.com/education/demos-and-tutorials/understanding-velocity-logic.html https://www.cannontrading.com/tools...ve-crude-oil-prices-trading-levels-4-23-2020/
Thank you, this is the best explanation of the situation I have read so far. Thank you for explaining it in an easier way. I was one of the rookies that bought into the USO ETF thinking it was a fund of OIL companies and realized it was investing in oil futures contracts. I now know a lot more about it, and am trying to recoup my losses... =(