So what is a futures contract, the difference between a monthly contract and a continuous contract? Moreover, how can a monthly contract drop into negative territory as what happened recently April 2020 when West Texas Intermediate (WTI) oil made history plunging into negative USD -37.63 leaving buys with a greater loss than their initial investment?
A futures contract is a financial derivative that obliges the buyer to purchase some underlying asset (or the seller to sell that asset) at a predetermined future price and date.
Why are future contracts beneficial to investors?
Futures contract allow investors to speculate on the direction of a security, commodity, or a financial instrument, either long or short, using leverage.
So most buyers of futures contracts are speculators. Some investors also use futures contracts for hedging the price movement of the underlying asset to help prevent losses from an unfavorable price change.
Futures contracts traded on the futures markets lists several individual contracts, each with a pre-determined lifespan. At any stage, the market consists of several contracts, or “delivery months.”
The traders be aware point Darren Winters makes is that some contracts have delivery months and others are continuous
So your exit from a futures contract, if it is a monthly contract, is already predetermined by the delivery date which is when that month’s contract expires.
So a buyer of a monthly contract where the price falls below the trader’s entry price when the contract expires has no option but to take losses or in the case of commodity futures contracts take delivery.
Continuous futures contracts, as the name suggests roll onto the next month, then the following month, and so forth
In short, traders need to factor into their trading plan that some future contracts have delivery months with predetermined expiry dates and others are continuous where the contract rolls on to subsequent months.
So why did the futures monthly contract, WTI oil April 2020 fall into negative territory?
The likelihood of a futures contract falling below zero, where the buyer of the contract loses his investment plus the cost of paying negative prices so as to avoid the greater cost of oil delivery storage (if storage were available) is a bizarre unprecedented situation. But we live in a bizarre world with negative interest rate policy, negative monthly future oil contracts. We will see many never happened before events in this transformation from a systemic crisis to new world order. When the cost of oil exploration, transportation exceeds the current market price, energy companies go bankrupt and the energy supply chain from exploration, to the refinery to haulage is broken. The enforced great lock-down has sliced off the invisible hand of the market. What could come next is an oil supply chain collapse, food shortage, famine, social unrest, war as the four horsmen of the apocalypse appear.
If it was written a decade ago that we will see negative interest rates with QE infinity, negative futures monthly oil contracts, and that more than half the world’s population would be in a totalitarian lock-down, private business forced to close, you would have wondered what is this person smoking.