Yoel Bender

How to Trade Crude Oil: What You Should Know

Published on
March 16, 2023

Oil is one of the most actively traded commodities on the financial markets, given its importance to the global economy. Being a finite commodity, its price fluctuates significantly due to supply and demand dynamics. The heightened volatility associated with the commodity makes it one of the most traded financial instruments for gaining exposure to the energy sector.

Oil prices vary depending on origin and supply and demand metrics. Based on origin, there are two commonly traded oil benchmarks. Brent oil and West Texas Intermediate (WTI). While looking to profit from the oil price, it is essential to know the difference between the two.

Source: Investyadnya.in

Brent oil is more prevalent as it is sourced from the North Sea and most countries worldwide. West Texas oil, on the other hand, is sourced from oil fields in the US, mainly in Texas and Louisiana. Additionally, Brent oil prices are widely affected by political, economic, and geographical pressures. Consequently, it tends to be highly volatile, providing unique trading opportunities.

Given that WTI is mainly sourced in the US, it is less widespread and thus not affected by international pressures or uncertainties.

There are three ways to trade oil.

1. Brent CFDs

Crude oil contracts for difference (CFDs) offer one of the most popular ways of trading or speculating on oil prices on the market. CFD Brent crude oil are derivative products that allow traders to bet on current oil prices. In this case, one agrees to exchange the difference between when a position is opened and when it is closed.

How to Trade Brent CFDs?

While Brent CFDs involve speculating on future oil prices, it requires a form of leverage to trade on various trading platforms. For example, most brokers would offer a loan that allows traders to buy or sell positions relatively bigger than what their actual capital can buy.

With leverage, one can open a buy or sell position on crude oil prices and gain profit on the difference between the opening and the closing prices. For instance, if crude oil was trading at $106 a barrel in the oil market and one opens a buy position, any price increase will be profit. On the other hand, if the trader were to close the position on oil prices rising to $109, the profit would be $3.

Nevertheless, the overall profit will depend on the number of contract differences one bought or the lots at which the trade was opened.

2. Oil Futures

While oil CFDs amount to over-the-counter trading whereby traders take advantage of prevailing prices, oil futures provide a way to speculate on future oil prices. With oil futures, traders agree to exchange an amount of oil at a set price in the future.

How to Trade Oil Futures?

Trading oil futures is not the same as trading oil CFDs. In this case, you will need a specialized account with a broker that offers futures trading. Once you can access the futures trading market, you can place trading orders to speculate on future oil prices. An oil futures contract represents 1,000 barrels of crude oil.

Oil futures Trading Strategies

For example, if oil is currently trading at $90 a barrel and you believe it will be worth more than $95 over the next month, you can enter into a futures contract with a broker. If oil prices rise to, say, $96 a barrel over the next month, the profit, in this case, will be $6 per barrel. If the trader had bought two contracts, the profit would be $12,000 ($6 x 2 x 1000).

Similarly, if oil prices over the next month plunge to $89 a barrel, the trader will incur a loss of $1,000 on contract expiration.

3. Trading Crude Oil Options

Oil options are traded the same way as an oil futures contract. The only difference is that there is usually no obligation on the trader's part to execute the contract. Additionally, there are two types of oil options, calls, and puts.

Any trader who feels oil prices will rise over a month can enter a call option to profit from the oil price increase. Likewise, a trader who feels oil prices will drop over the next month will enter a put option to profit from the oil price decline.

Crude Oil Option Trading Strategies

Let's say Brent crude prices are trading at $90 a barrel. Based on the analysis, a trader believes that oil prices will rise but is not sure. The trader can enter a call option with an options broker. Every contract that the trader enters is equivalent to 1,000 barrels. The strike price for the contract will be $90. The premium, which is the cost incurred to open the call option, could be $2 a barrel. Consequently, each contract will cost $2,000.

Source: IG.com

If, after one month, oil prices rise to $95, the trader will have generated a profit of $5 a barrel, translating to a $5,000 profit ($5 x 1,000). However, the profit reflected in the account will consider the premium, which is the cost incurred to open the trade. Consequently, the trader will end up with a profit of $5,000 - $2000 = $3,000 for each call option entered

Alternatively, if oil prices plunged to $85 a dollar barrel, the trader would be in for a $3,000 loss. However, instead of incurring a much more significant loss, the trader can forfeit executing the call option before the expiry date and incur only the premium, which is $2,000 per call option contract.

Oil Trading Strategies and Tips

While looking to profit from oil price fluctuations, there are several things that one must keep in mind. Top on the list is the factors that affect supply and demand and consequently trigger price fluctuations.

The influence of OPEC on the oil markets cannot be taken for granted. The oil cartel regulates the amount of oil that hits the market. As a result, oil prices tend to decline whenever OPEC members overproduce, leading to a glut of supply relative to the overall demand. Similarly, whenever the cartel cuts supply amid soaring demand, there is always a tendency for oil prices to increase.

Source: Pinterest.com

The global economic outlook is another factor that affects sentiments on the oil markets, leading to price fluctuations. Whenever the global economy is booming on the back of heightened industrial activities, oil demand is usually high, something that often causes prices to increase. On the other hand, whenever there are concerns about the global economic outlook, prices tend to drop amid worries about demand.

Geopolitical developments in some of the biggest oil producers are another essential aspect to consider. For example, the prospects of war in the oil-producing nations often cause prices to increase amid concerns that the oil supply will come under pressure.

The strength of the US dollar also affects oil prices on the market, given that all the major benchmarks are priced in the global reserve currency. Consequently, whenever the dollar strengthens, there is always a tendency for oil prices to decline. Similarly, whenever the dollar weakens, oil prices tend to increase.

Bottom Line

Crude oil is one of the best financial instruments to trade, given the unique opportunities that always crop up. Futures Options and Contracts for Difference are some instruments that one can use to speculate on oil prices. In addition, it is important to know all the factors that might affect prices before trading.

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