crude oil futures
China and crude oil are running the show in the financial futures markets.
We aren't saying it is right, or even rational, but it is clearly China's economic data and volatility in crude oil that are in the driver's seat. Data out of China continues to disappoint despite some rather dramatic actions being taken by the country's central bank. We have to admit, we thought the futures markets (commodities and financials) would react more positively by moves made by the People's Bank of China. Instead, investors have taken their stimulus actions as reason to panic.
Crude oil has seen the largest percentage move in over two decades. In fact, we've seen the asset class move more in 4 trading sessions than some commodity markets move in years. In any case, those that have traded crude oil futures know that volatility is par for the course. The problem with oil market volatility is that it bleeds into the financial futures markets. Although yesterday's crude oil rally likely postponed selling the the S&P futures, today's weakness in oil was a good reason for equity traders to hit the sell button.
Are we finally going to see the correlation between stocks and oil soften?
In overnight trade, it was the same 'ol, same 'ol. Crude and stock index futures moved together in lockstep; we saw the same action in early day session trade. Yet, after the Fed meeting, each market seems to be willing to have it's own reaction to the Fed news. Crude oil squeezed, and held, well into positive territory while the stock market remained under moderate pressure. This probably isn't an immediate game changer, but it is a step in the right direction and is worth noting. Both assets trading as one isn't healthy for the financial markets, or the commodity markets. In fact, it should eventually be bullish for stocks...after all, they've taken a hit at the hands of the crude oil futures slide.
The big news of the day was the Fed meeting. The meeting itself was considered to be "dead" going in. This means that few (nobody) believed there was a chance for a policy change, but traders were hoping for hints regarding the pace of upcoming interest rate hikes. In a nutshell, they were very careful to leave a rate hike in March as a possibility, while simultaneously noting softening conditions that probably won't warrant another immediate tightening of credit. In the end, the news was relatively neutral to slightly bearish for stocks, but seems to have been enough to throw cold water on market volatility, which is a blessing in itself.
OPEC failed the markets, but a Kuwaiti Oil worker strike came through
It was only a matter of time before the overly bearish supply fundamentals in crude oil were overshadowed by a supply disruption at the hands of Mid-East turmoil. What some believed on Sunday night was the beginning of another precipitous crude oil decline, quickly turned into a sharp energy rally on news of a Kuwaiti oil worker strike. Adding fuel to the fire was a report released this morning by the U.S. Energy Information Administration suggesting distillate stocks (heating oil/diesel/gasoline) experienced small declines. Remember, commodity markets don't need an actual change in fundamentals to turn things around, they just need the perception that it is possible. In other words, crunching supply and demand data isn't going to change momentum.
The direction of crude oil matters to financial futures traders because it is was a big weight on equities earlier in the year. Higher energy prices eases concerns of contagious debt defaults in junk bonds, and could eventually put layed off shale oil workers back on the job.
Wednesday's long squeeze quickly became the Thursday/Friday short squeeze
Although in the heat of the moment on Wednesday morning, most online and TV chatter suggested the capitulation had yet to come, it seems it already had. The ES has rebounded nearly 100 points from Wednesday's lows and crude oil has bounced nearly $5.00 per barrel. It is unfortunate that margin calls, and fear, likely left a handful of bulls watching the recovery from the sidelines after they had realizing massive loses. Unfortunately, when volatility picks up, so do these types of stories.
Although this type of stop loss running and squeezing out the weak hands has always been a part of the financial and commodity markets, I would argue that computerized trading has increased the frequency of exaggerated moves. In the same manner natural gas futures traded well beyond reasonable fundamentals for three for four days in December prior to a quick snap back rally, we saw the same nonsense in oil and, therefore, equities.
If it weren't for the no crying in commodities rule, we might have shed a tear. Luckily most clients were able to ride the storm with most positions in tact...and at least for today, the S&P, crude oil, and the 10-year note is all moving our way.
One of the most frustrating aspects of trading commodities is getting comfortable with how each futures and options contract is quoted, what the point value or multiplier of each contract is, and most importantly how to calculate the profit, loss, and risk of a trade.
Each commodity futures contract is standardized, but in comparison to those with differing underlying assets they are often worlds apart. This can be extremely overwhelming for a new futures trader; particularly because stock traders enjoy the simplicity of consistent math regardless of the product being traded. I hope that the following explanations, and my years of experience as a commodity broker, help to shorten your learning curve. Additionally, I hope this article provides you with a good base of information to begin your journey in the challenging trading arena known as commodity options and futures.
Unfortunately, until recently there hadn't been much in the way of uniformity in the commodity industry. Today, the Chicago Mercantile Exchange Group (CME Group) owns and operates most U.S. futures exchanges, but it wasn’t always that way. Early on, there were a handful of major domestic futures exchanges working completely independent of each other. Each of the exchange had differing rules and procedures; further each commodity listed on those exchanges had, and still have, various contract sizes and specifications. As a result, the point value and quoting format varies widely. For example, some commodities are referred to in fractions and others in decimals. Some decimals depict the difference between dollars and cents, others between cents and fractions of a cent. The merger of the Chicago Board of Trade, the Chicago Mercantile Exchange, and the New York Mercantile Exchange was a big step in bringing some congruency but, regrettably, reading and calculating commodity prices will never become easier.
Reading and Calculating Commodity Prices
Quoting Grain Futures
The grain complex is perhaps the easiest to remember when trading in futures simply because four of the major contracts included are similarly quoted. Wheat, corn, soybeans and oats are all priced in dollars and cents. This is true for both futures and the corresponding option contracts. If you are proficient in adding and subtracting fractions, these contracts should be a breeze; if not it may take you a while to become familiar enough with the pricing method to begin trading.
Each of the grain futures contracts listed above are quoted in fractions using eight as a denominator. In other words, they are referred to in eighths of a cent. Because eight will always be the denominator the fractions are not reduced. The minimum tick for these contracts in the futures market is a quarter of a cent or 2/8ths. Thus, if corn was trading at $4.15 1/4 (four dollars and fifteen and a quarter cents) the price would be displayed on a quote board as simply 415'2. The two represents the un-reduced fraction 2/8. If corn futures ticked lower, the new price would be 415, or $4.15. It cannot trade at 415’1 because the minimum tick is a quarter of a cent.
With this information, you have probably realized that a half of a cent is denoted by 4/8ths and three quarters of a cent would be displayed as 6/8ths or simply 6. In other words, if wheat was trading at $5.70 3/4 it would be displayed on a quote board or price ticker as 570'6. Likewise, $5.70 1/2 would be listed as 570'4. If fractions aren't your thing, you can avoid using them in your calculations by simply replacing the fraction with .25, .50 and .75 respectively.
Calculating Profit and Loss in Grain Futures (Corn, Wheat, Soybeans)
Each penny of movement in these grain futures will result in a profit or loss for the trader in the amount of $50. To illustrate, being long corn futures from $4.00 with the current futures price at $4.01 the trade is profitable by exactly $50. To expand on this idea, the minimum tick of a quarter of a cent (2/8ths) results in a profit or loss of $12.50. Once you are armed with this knowledge, computing profit, loss and risk in terms of actual dollars in your trading account is relatively simple.
A trader long soybeans from 901'4 ($901 1/2) liquidates the position at 926'6 to net a profit of $1,262.50 before considering commissions and exchange fees. This is figured by subtracting 901'4 from 926'6 and multiplying that number by $50.
926'6 - 901'4 = 25'2
25'2 x $50 = $1,262.50 (minus commissions and fees)
The Odd Couple of Soybean Futures (Soybean Meal, and Soybean Oil)
The less talked about soybean contracts are the byproducts of the beans themselves. Soybeans are crushed to extract oil (soybean oil), what is left is a substance known soybean meal. Soybean oil can be found in many of the foods that you consume on a daily basis while soy meal is most often used as animal feed.
Soybean Meal Futures
While both of these products are derived from the same bean, in terms of futures trading they have few similarities. Soybean meal is quoted in dollars and cents per ton based on a contract size of 100 ton. To clarify, if soymeal futures are trading at 390.50 this is referring to three hundred ninety dollars and fifty cents per ton or $390.50. If the market drops by 30 cents (sometimes referred to as points) the new price would be 390.20. Each dime in price movement represents a $10 profit or loss per contract. Thus, if a trader sells soymeal futures at 395.20 and buys the contract back at 390.10 he realizes a profit of $510 per contract. This is calculated by subtracting the purchase price from the sale price and multiplying it by $100. This makes sense because if each dime in the commodity price is equivalent to $10 in your trading account, then each $1 change in the commodity price will represent a profit or loss of $100 before considering transaction costs.
395.20 - 390.10 = 5.10
5.10 x $100 = $510 (minus commissions and fees)
Soybean Oil Futures
Soybean oil futures trade in contracts of 60,000 pounds and are quoted in cents per pound. If you see a price of 38.20 it is actually referring to $0.3820 or 38.20 cents per pound. If the daily change was a positive .10, this represents a tenth of a cent price appreciation. Each 1/100th of a cent is worth $6 to the trader; thus each full handle or cent is equivalent to a profit or loss of $600 in the futures market. For example, if a trader went long soybean oil futures from 37.00 and was forced to sell the position at 36.20 at a loss, the total damage to the trading account of the speculator would have been $480. This is figured by subtracting the purchase price from the sale price and then multiplying by $6.
37.00 - 36.20 = .80
80 x $6 = $480 (minus commission and fees)
Livestock Futures (The Meats)
The complex known as "the meats" consists of feeder cattle, live cattle and lean hogs. Newer commodity traders are sometimes disappointed to learn the infamous pork belly futures contracts have been delisted from the exchange. Nevertheless, as an experienced futures broker I’m confident the trading community is better off without a futures contract written with pork bellies as the underlying asset. Prior to their delisting from exchange offered products, pork belly futures were thinly traded, involved wide bid/ask spreads, excessive volatility, and left countless traders maimed.
Each of the livestock futures are quoted in cents per pound and there are one hundred points to each cent. With the exception of feeder cattle which have a point value of $5, the meats have a point value of $4. Therefore, a penny move (100 points) would be equivalent to $400 in profit or loss in live cattle and lean hogs. An equivalent move in feeder cattle would yield a profit or loss of $500.
The meat futures contracts are commonly quoted with decimals which causes confusion. Don't assume because there is a decimal in the quote that it is meant to depict dollars and cents. The digits beyond the decimal point are referring to the fraction of a penny in which the price is trading. For example, if feeder cattle futures are trading at 210.90 this is equivalent to $2.10 and 9/10ths of a cent.
Let's look at an example on how profit and loss would be calculated when trading live cattle futures. A trader long live cattle from 199.30 gets filled on a limit order working to sell at 202.40. This trade was profitable by 3.1 cents or $1,240 and can be calculated subtracting the entry price from the sales price and multiplying the difference by the multiplier. In the case of live cattle it is $4 a point or $400 per penny.
202.40 - 199.30 = 3.10
3.10 x $4 = $1,240 (before commissions and fees)
Foods and Fibers (The Softs)
Coffee, orange juice, cocoa and sugar all fall into a commodity futures category often referred to as the "softs". With the exception of cocoa, each of these futures contracts are quoted in cents per pound. Accordingly, although the multiplier will be different, the methodology in figuring out profit, loss and risk on a trade will be very similar to that of the meats.
Cocoa, on the other hand is quoted in even dollar amounts per ton; prices are not broken down into cents. In other words, if cocoa is trading at 3100, it is actually going for three thousand one hundred dollars per ton. There are ten tons in a contract, so multiply by ten or add a zero to get the true dollar amount. If the market closed higher 14 ticks in a trading session, a trader would have either made or lost $140.
Coffee futures trade in contracts of 37,500 pounds making each penny of movement worth $375 to the trader. For example, if prices move from 130.00 to 131.00 a trader would have made or lost $375 before considering transaction costs. Similar to livestock futures, the decimal point isn't meant to separate dollars from cents it is a way of breaking each penny into fractions of a penny. Thus, if the price rises from 130.50 to 131.00 it has appreciated by half of a cent which is equivalent to $187.50 per contract to a commodity futures trader.
Orange Juice Futures
An orange juice contract represents 15,000 pounds of the underlying product. Therefore, each cent of price movement results in a profit or loss of $150 to a trader. Like meat futures and coffee, orange juice is quoted in cents per pound with a decimal that simply represents a fraction of a cent. A tcopprader long orange juice from 120.00 with the current market price at 118.50 has an unrealized loss of 1.5 cents or $225 (1.5 x $150).
Sugar #11 futures (not Sugar #14 futures) are traded based on a contract size of 112,000 pounds. With that said, each tick in sugar is worth $11.20 to the trader and each full handle of price movement (or penny) is equivalent to $1,120. Once again, don't mistake the decimal for separation of dollars and cents. If sugar is trading at 12.20 cents per pound it will be displayed by a quote service as 12.20. A trader long from 11.95 would be profitable at 12.20 by .25 cents, or $280, figured by multiplying the difference between the current price (12.20) and the purchase price (11.95) by the point value ($11.20).
Cotton isn't a food, it is a fiber. Nonetheless it is most often grouped with the softs (sugar, cocoa, orange juice and coffee futures) due to the fact that it trades on the same exchange (Intercontinental Exchange, or ICE). Cotton futures trade in 50,000 pound contracts and are quoted in cents per pound; again, the decimal point isn't intended to separate dollars and cents. Rather it separates cents from fractions of a cent. In other words, if cotton is trading at 68.50 it is read as 68 1/2 cents. Due to the contract size, each tick of price movement is worth $5 to a trader; therefore if a speculator sells cotton at 65.40 and is stopped out with a loss at 67.30 the total amount of the damage would be 1.9 cents or $950 (190 points x $5).
Lumber futures are not traded on ICE with the other softs, but are often referred to in the same category. For reasons unknown, lumber futures attract beginning traders. Perhaps it is because it is the epitome of the definition of a commodity due to its widespread usage. Nonetheless, it is a sparsely traded contract by speculators and until liquidity improves I don't necessarily recommend trading it. Prior to the Chicago Mercantile exchange eliminating open outcry futures trading pits, I can recall walking by the barely recognizable lumber futures trading pit. There were a total of three market makers passing the time by reading a newspaper. As a speculator, it is never a good idea to trade in a market in which your order will be one of a handful of fills in the entire trading day.
If you do insist on trading lumber futures you must be willing to accept wide bid/ask spreads and a considerable amount of slippage getting in and getting out of your position. The contract size for the lumber futures contract is 110,000 board feet and it is quoted in dollars and cents. Accordingly each tick of price movement represents $11. In this case, the decimal is used in its usual context. If the market is trading at 246.80, it is interpreted as $246.80.
Precious Metals Futures
Gold, Platinum and Palladium Futures
Gold, platinum and palladium futures are quoted just as they appear, the decimal included in the quotes are intended to separate dollars and cents. The numbers to the left of the decimal are dollars and the numbers to the right are cents. In other words, a point in these metals contracts is synonymous with a cent. For example, if gold is trading at $1130.20 and rallies 60 cents the price will be 1130.80, or simply $1130.80. Platinum and palladium are treated the same; there are no surprises here. However, their point values do differ. Palladium has an equivalent point value as gold at $100 per dollar of price movement, but the point value and contract size of platinum is half of that of gold and palladium. This is because of their futures contract size; a gold futures contract, as well as palladium futures, represent 100 ounces of the underlying commodity, but platinum is only 50 ounces.
In regards to gold futures, each penny of price movement results in a profit or loss of $10 to the trader. Therefore, each full dollar movement in price represents $100 of profit or loss. Accordingly, if gold rallies from $1149.20 to $1156.80 a long trader would have made $7.60 or $760 and a short trader would have lost that amount (not considering commissions and fees).
1156.80 - 1149.20 = 7.60
7.60 x $100 = $760 (minus commissions and fees)
The manner in which silver futures are quoted is more similar to grains such as corn and wheat than it is the other precious metals. A silver contract represents 5,000 ounces of the underlying commodity creating a cent value of $50; for every penny that the futures market moves a trader will make or lose $50. Likewise, silver trades in dollars and fractions of a cent. If the price is quoted as 16.345 it should be read as $16.34 1/2. Please note that the traditional version of the silver contract traded on the COMEX division of the CME Group trades in halves of a cent, but there are mini versions of silver futures that trade in tenths of a cent, such as 1634.1 or sixteen dollars and thirty four and one tenth of a cent.
Calculating profit and loss in silver futures is identical to doing so in corn, wheat or soybean futures. If you sell silver at 13.450 ($13.45) and are stopped out at 1362.5 ($13.62 1/2) you would have lost 17.5 cents or $875 ($50 x 17.5).
Unlike the other metals which are referred to in terms of cents per ounce, copper futures are quoted in cents per pound. The contract size is 25,000 pounds making the multiplier $250 for a penny move. Simply put, if copper rises or falls by one cent a futures trader would make or lose $250. This makes sense because if the price of copper goes up by 1 penny you would make 25,000 pennies on a long futures position. Also unlike gold futures, copper prices trade in fractions of a cent. If you see copper quoted at 3.055 it is trading at $3.05 1/2. Likewise, if copper rallies from this price to 3.450, it represents a gain of 39.5 cents or $9,875 ($250 x 39.5) per contract. This sounds great if you happened to be long, but a short trader during this move likely lost a lot of sleep. There is a mini version of copper futures, which is probably more appropriate to most commodity traders due to it’s reduced contract size of 12,500 pounds.
Crude Oil Futures
Crude oil is one of the most talked about commodities but is also one of the most challenging of the futures markets to speculate. WTI (West Texas Intermediate) Light sweet crude (not to be confused with Brent crude oil) is quoted in dollars per barrel. From a commodity trading standpoint, it is relatively simple to calculate profit, loss, and risk in crude oil futures because it is quoted in dollars and cents, as we are accustomed to in everyday life. The contract size is 1,000 barrels, so each penny of price movement in crude represents $10 of risk to a commodity trader.
A price quote of 65.00 is just as it appears, $65.00 per barrel of crude. A drop in price from 65.00 to 63.00 is equivalent to a $2,000 profit or loss for a futures trader. Remember, each penny is worth $10 to a trader and a $2 move in price is 200 cents.
Heating Oil Futures
Heating oil futures and unleaded gasoline are much more complicated to figure. Both are quoted in cents per gallon, similar to how it is displayed to you at a gas station pump. Consequently, in both cases the decimal point separates the dollars from the cents and each of them trade in fractions of a cent. The contract size for each is 42,000 gallons, so each point in price movement is worth $4.20 cents to a futures trader and each penny (100 points) is worth $420. For example, if heating oil futures are trading at 2.1060 ($2.10 6/10) and rallies to a price of 2.2140 ($4.21 4/10) the futures contract has gained 10.8 cents or $4,536 (10.8 x $420). By this example you can see how easily money can be made or lost in the futures market. A price move of less than 11 cents could result in a profit or loss of several thousand dollars.
Natural Gas Futures
Natural gas futures are quoted in BTU's or British Thermal Units which is a measurement of heat and has a contract size of 10,000 mmBTU or million BTU's. Each tick of price movement in this contract is valued at $10 and there are 1000 ticks in a dollar of price movement. Thus, for every dollar move in the natural gas futures market, the value of the contract appreciates or depreciates by $10,000. To illustrate, if the market rallies from 3.305 or $3.30 1/2 to 4.305 a trader would have made or lost $10,000 on one futures contract. This might be enough to deter you from this market, unless of course you have deep pockets and substantial risk tolerance.
Currency futures are listed on the Chicago Mercantile Exchange and are, for the most part, traded in "American terms". This simply
means that the currency prices listed in the futures market represent the dollar price of each foreign currency. In order to understand the point of view of the futures price ask yourself; "How much of our currency does it take to buy one theirs?"
If the Euro is trading at 1.1639, it takes $1.16 39/100 U.S. greenbacks to purchase one Euro. The value of one futures contract is 125,000 Euro so each tick higher or lower changes the price of the contract by $12.50 and translates into a profit or loss to the trader in that amount. Like the Euro futures contract, the majority of currency futures have a tick value of $12.50; others that share this characteristic are the Swiss Franc, and the Japanese Yen futures contract. The Australian Dollar and the Canadian Dollar both have a tick value of $10 and the British Pound fluctuates in ticks of $6.25. Once you know the tick value of each of these contracts, it is easy to compute the dollar amount of risk, profit and loss. For example, a trader that is long the Euro from 1.1239 and liquidates the position at 1.1432 would be profitable by 193 ticks or $2,412.50 (193 x $12.50).
Trading volume was muted ahead of the Fed announcement
Pending home sales were a bullish surprise this morning. According to stats, homes under contract for sale were up 1.4% in March. However, it was the crude oil inventory report that garnered the largest reaction...at least until traders remember it was an FOMC day, and stock prices reverted right back to where they started. The S&P fell markedly following a $1.00 drop in crude oil futures at the hands of the latest weekly inventory report, but both oil and the S&P recovered later in the day.
Naturally, the story of the day was the Fed. The Fed didn't change interest rate policy, as was widely expected. They also basically copy and pasted their policy statement from the last meeting. In short, today's FOMC meeting was a non-event.
Holiday futures markets are around the corner
Perhaps the most valuable lesson I've learned in my decade (plus) time as a commodity broker is that holiday markets are not to be reckoned with. Volume is light and trading desks are filled with the second, and third, string staff. As a result, the markets can make dramatic and uncharacteristic moves. An example of this that still stings, is last year's Thanksgiving day crude oil futures collapse. The market was technically closed for the holiday, but the CME decided to let futures trade for an abbreviated session on the morning of Thanksgiving day. As a result of the light volume, and an ill-timed OPEC meeting, crude oil fell roughly $7.00 in single clip. In a nutshell, this is the time of year to keep trading light.
In regards to the S&P and Treasuries, the holidays have an interesting influence on trade. Nearly every year (I'm not exaggerating), we see an end of the year melt-up. It is often a very slow moving grind, but it eventually adds up to a significant move.
More pertinent to the current market; the week of Thanksgiving is statistically highly bullish. In fact, the Stock Trader's Almanac suggests that it might be a good idea to look for weakness prior to Thanksgiving to enter bullish trades, and strength after the holiday to exit. In fact, in the Dow, netting the day before and after Thanksgiving day has combined for only 13 losses in 62 years.
Crude oil futures are driving the bus
Unfortunately for anyone holding stocks in their retirement portfolio, or anybody playing the long side of the e-mini S&P in the future market, stocks aren't trading on their own fundamentals. The broad market is simply following crude oil lower, and occasionally temporarily higher.
It is important to remember the last time crude oil traded near $30, the S&P 500 was near 1,100, and the world was concerned we would no longer have a functioning banking system. This time around, we are in a much different situation. Unless I'm missing something, it is far less dire (unless you are long commodities). Nevertheless, something has to come back into line. Either oil, and the other beaten down commodities need to make a move higher, or stocks need to move lower.
In recent days we've been "blessed" with some rather bold analyst calls in the commodity space. Some large and relatively well respected banks and analysts are calling for oil to fall to 20s per barrel, and in one instance expectations are for $10 crude oil!!! Perhaps these prediction will be accurate, but we have serious doubts. It smells a little like the widespread analyst expectations for $200 crude oil in 2008 when $150 crude oil was considered "cheap".