Question

What are futures contracts? Give an example of how a futures contract can be used as protection against commodity price changes. Why did the price of the May WTI futures contract fall to about -$40. Is there a surplus of oil? What does this have to do with the state of the economy? Explain.

Note: Each WTI contract is for 1000 barrels of oil, and each barrel contains 42 gallons.

Please write at least 10 sentences.

Answer 1

Future Contract:

A future contract is an agreement between two parties that commits one party to buy an underlying financial instrument (bond, stock or currency) or commodity (gold, steel or oil) and one party to sell a financial instrument or commodity at a specific price at a future date. The agreement is completed at a specified expiration date by physical delivery or cash settlement or offset prior to the expiration date. In order to initiate a trade in futures contracts, the buyer and seller must put up "good faith money" in a margin account. Regulators, commodity exchanges and brokers doing business on commodity exchanges determine margin levels.

Example: - Going Long on a Single Stock Futures Contract

Suppose an investor is bullish on stock x and goes long on one May stock future contract (contract size = 100) on stock x at $ 10. At some point in the near future, stock x is trading at $ 16. At that point, the investor sells the contract at $16 to offset the open long position and makes a $ 600 ($6*100) gross profit on the position.