Currency Market, Commodity Market, and Government Securities

Lesson -> The Crude Oil - Part 03

12.1 - The contract

Crude oil is the most traded commodity on MCX. On average, crude oil trades on MCX exceeds Rupees 3000 Crores per day. This is equivalent to approximately 8500 barrels per day of crude oil. Both corporate and individual traders participate in the crude oil market. You can expect to see both upstream and downstream companies (ONGC. CAIRN. Reliance.) placing orders on MCX. These institutional orders are used to hedge their exposure in spot (physical) markets, as I would guess. Retail traders, on the other hand speculate heavily on crude oil prices.

I encourage you to look at the MCX "Bhav Copy." This will give you an overview of a contract's liquidity as well as its volume.

Two major Crude oil contracts are traded on the MCX.

  1. Crude Oil (the main contract or the big crude oil)
  2. Crude Oil Mini (the Baby Version)

This chapter will explain how these contracts work - from expiry to margins and P&L per tick.

12.2 - Crude Oil: The big contract

The big crude oil contract has a daily average traded value of Rupees 2500 Cr and is definitely one of the most valuable contracts that trades on MCX. Let's not waste too much time and get to the contact information for the big crude.

These are the contract details:

  • Price quote - per barrel
  • Lot Size - 100 Barrels
  • Tick Size - Rs.1/
  • P&L per tick - Rs.100/-
  • Expiry -19/20 the of each month
  • Delivery units - 50,000 barrels
  • Physical Delivery Mumbai / JNPT Port

Let's look at this information more closely. Crude oil on MCX can be quoted per barrel (each barrel equals 42 gallons, or approximately 159 litres). Take a look at this image to see Crude oil's market depth.

You can see that the Crude Oil contract will expire on 19ThDec 2016 barrels are trading at Rs.3197/o, as evidently we know the price quote. Per-barrel basis.

TheLot size 100 barrelsThis means that, if you are looking to buy crude oil (or go long), the value of such an agreement will be -

Lot size * price quote

= 100 * 3198 (offer to go long

=Rs.319 800/-

The contract value of crude oil is this, but what about margins? The margin for crude oil is slightly lower than other commodities. The margin requirement for carrying the position forward overnight is approximately 9%.

This means that 1 lot (100 barrels) of crude oil requires a margin deposit in the amount of -

9% * 319800

= Rs.28782/-

This is a snapshot of the same.

For an overnight position, the margin requirement for NRLM is Rs.29.114/-. This assumes that Crude costs Rs.3,253/+. If you want to trade intraday using MIS, the margin requirement will be approximately 4.5%. As you can see, the margin required under MIS is only Rs.14,557/+.

12.3 - Choosing the right contractor to trade (expiryLogic)

Every month, new crude oil contracts go on the market. Six months after the date of entry, new crude oil contracts expire. The November 2016 contract will expire in six months. That is, in May 2017. This information is posted by MCX in their circulars on a regular basis, but it can be confusing for me to understand the expiry table. This is what MCX wants to communicate -

Current monthInitiated a contractExpiry Date
November 2016,May 2017,19 19 May
December 2016,June 201719 th June
January 2017,July 2017,19 19 July
February 2017,August 2017,21 1st August
March 2017,September 2017,19 9th September
April 2017,October 2017,18 thOctober
May 2017,November 2017,17 17 November

This is how the circular table reads:

As I write this, it is November 2016. This means that the November 2016 contract must have come into effect in May 2016.

However, it is to noted that

  1. Each month, a new contract is launched 6 months ahead of time (long-dated contracts).
  2. These contracts will expire 6 months after the expiry date, at or around 19 th.
  3. This means that each contract is valid for six months on the market.

Always choose the nearest month contract for active trading. Assuming that today is November 5, 2016, I would choose the November 2016 contract, which expires on 19 November to trade. As we get closer to expiry, I would shift to the December 2016 agreement. This is because of one simple reason. The current month contract has the highest liquidity (November 2016, in this case). The next month's contract will see liquidity increase (i.e. As we get closer to the end of the current month, liquidity increases.

Even though they exist on the market, all the other contracts are meaningless until they become current.

12.3 - Crude Oil Mini contract

The Crude Oil mini is a favorite among traders. This is because it's easy to use.

  1. Margin required is less
  2. The P&L per tick can be a lot lower - Did you know that people would rather see less loss than higher profits?

These are the details of the contract -

  • Price quote - per barrel
  • Lot Size - 10 Barrels
  • Tick Size - Rs.1/
  • P&L per tick - Rs.10/-
  • Expiry -19/20 the of each month
  • Delivery units - 50,000 barrels
  • Physical Delivery Mumbai / JNPT Port

Take a look at this quote -

Crude oil Mini, December futures trades at Rupees 3.00/- per barrel

Rs 3210*10

Rs 32100

In percentage terms, the margin required is slightly higher at 9.5% for NRML and 4.8% in MIS.

For NRML, the margin requirement is Rs.3,049/= while for MIS it is Rs.1,540/=. This margin is clearly less than that required for big Crude oil purchases.

Other than lot size and margins, all other features are the same for the crude oil contract.

12.4 - Crude Oil Arbitrage

Take a look at this image -

The snapshot shows Crude Oil December future (big-crude contract) and its market depth. The second snapshot shows the Crude Oil Mini Dec contract and its market depth.

Both of these contracts should trade at the exact same price, assuming everything else is equal. Because the underlying oil is the same, they cannot trade at different prices. This is actually what we see here: both Crude oil contract trade at Rs.3,221/=

What if they don’t?

Let's suppose that these two contracts trade at different prices. Crude Oil trades at Rs.3,221/ and Crude Oil Mini trades at Rs.3,217/. Is there a trading opportunity? We do indeed have an arbitrage opportunity. Here's how you can trade it.

Crude Oil - 3221

Crude Oil Mini = 3217

Risk free profit potential (arbitrage) = 3221-3217 = 4 points

Trade Setup-

In any arbitrage trade, the rule of thumb is to always buy the less expensive asset and sell it. In this instance, -

We purchase the crude oil mini at 3217, and then sell it at 3221. For the best arbitrage opportunities, it is important that we trade identical values.

Crude oil's contract value is 3221 * 100 = Rs.3,22,000.100/-

The contract value for Crude oil mini is 3217 * 10, or Rs.321,170/-

This means that one could buy 10 lots at 3217 of Crude oil mini and 1 lot at 3221 of crude oil. This will ensure that arbitrage is possible because the contract sizes are identical.

The arbitrage profit will be locked in once the trade is executed efficiently. In all cases of arbitrage, the price will eventually converge to one price point. Assume that the price eventually converges at 3230.

We gain +13 points on the crude oils mini and lose -9 on crude oil. On a net basis, however, we gain 4 points.

The 4 points are always guaranteed, regardless of the price.

These sweet opportunities are unlikely to come along often, and algorithms will grab them. Sometimes, such opportunities can last for minutes.

Keep an eye out for trading opportunities and, if you do find one, know what to do.

We have now come to the end our discussion on Crude Oil. In the following chapters, we'll be focusing our attention on "Metals".

To Summarize

  1. Crude Oil and Crude Oil Mini are the two available crude oil contracts.
  2. The lot sizes of both contracts are different. The lot size for the big crude oil is 100 barrels, while that of the crude mini is only 10 barrels.
  3. The price quote is per barrel.
  4. Each month, new crude oil contracts are created. These contracts expire six months later.
  5. The 19 th month is when expiry occurs.
  6. Maximum liquidity is attracted by the current month contract.
  7. Arbitrage between two crude contracts is possible, but it must be done with similar contract values.