How Oil Futures Work

If you think the price of oil will rise, buy low-priced oil contracts.
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Savvy investors can take advantage of changing commodities prices by trading futures contracts. You can make a lot of money, but you could also lose big; you could call it legalized gambling. If you are prepared, educated and you love anxiety, oil futures contracts might be just up your alley.


An oil futures contract is an agreement to buy or sell a specified amount of barrels of oil at a specified price on a specific date. Although these contracts are binding and based on real commodities, speculative investors trade them on a market with no intention of actually purchasing or delivering any products.


Writers create contracts in order to lock in prices in case of fluctuation. For example, if you produce oil and you think prices will go down, you can write contracts to lock in prices now. Similarly, if you believe that prices will go up, you'll buy contracts that lock in lower prices. Futures contracts are often used by pairs of business professionals to hedge their own bets.


Traders who aren't interested in actual products will buy and sell these contracts in order to benefit from changing prices. If you think that prices will go up, you'll buy the futures contract to deliver goods at $80 a barrel, and then sell them to someone else before the due date. If you buy the same position but the price begins to decline before the contract due date, you can sell the contracts to someone else who still thinks that prices will rise or that they'll hold steady for a profit.


The major risk for investors is that oil prices will move in the opposite direction of your position. You must get out of the position before the due date, or you'll end up with a lot of oil at your doorstep that will cost you a lot of money. If necessary, you'll have to sell at a loss to close out your position before the due date of the contract.

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