With only difference that it *might* happend that they don't converge when the April comes for expiry...or converge only partially. And what do I do then? I have to roll contracts and it might happen that front end of the curve is the steepest and thus by rolling I am paying a rolling yield. With physical it's a sure-fire thing
Anyone can explain this WTI backwardation?
- Thread starter UFBS
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With only difference that it *might* happend that they don't converge when the April comes for expiry...or converge only partially. And what do I do then? I have to roll contracts and it might happen that front end of the curve is the steepest and thus by rolling I am paying a rolling yield. With physical it's a sure-fire thing
Lol why? The prices might fall till you get future's delivery? Then you change strategy and do something else. In the end you ended up with a same quantity of oil as you had in the tank, risk free. Of course you could have straight sold at a higher (current) price, but than it's a straight speculation where you lose if the price goes up.
Okay, you really need to move away from this "risk free" idea because it's not the case.
Per your own example, let's say we have the following:
April $100
Aug $96
You sell physical crude at $100 and empty out your tanks. You buy Aug futures at $96.00 to hedge your injection. If prices fall to $70, you unwind your hedge for a $26 loss, but buy the physical on the spot market for $70. However, you effectively just paid $96 for a $70 product that you now have to hedge with a $65-$75 forward curve or sell on the spot market for $70.
You "make" $4 on the physical April/Aug spread and lose $26 on your injection, net loss of $22.
Conversely, if prices rise to $120, you unwind your futures for $24 gain, but pay $120 in the cash market for the physical that you sold for $100, for a $4 net gain.
The entire scenario is hardly risk free.
So basically if the prices stay level or rise, you are guranteed a 4$ profit. Only if prices drop, and drop for more than 4$, you realize a net loss, in dollar terms. In terms of oil in the tank, you are back where have you been - same quantity of oil you had, just it's now worth less in dollar terms due to price decline.
This strategy actually reduces risk compared to straight speculation (i.e. buying oil and having it wait in a tank) since it's basically a covered call writing.
But of course if you know that there is a high probability of price going DOWN, it pays off to straight out speculate and sell right now to capture the best price, since it's going down "for sure". But this is not happening.
Other way, if you believe the price is going UP substantially it pays out better to buy calls, but who is that who was so brave to cause a mini-rally in wti today with such a berish bias still in the market?
It's great you're thinking about this stuff, but the simplicity with which you imagine a trade like this can be executed is just not accurate. After costs your $4 dwindles to $2.50-3.00, and the only way this becomes risk free is if the Aug $96 put can be bought for less than $2.50-3.00.
The only way it becomes viable and worthwhile is if the Aug $96 put were trading under $1-1.50. With vols where they are however, the atm put in Aug is worth ~$5.25.
I can't argue, if you've got really strong arguments btw
And I laid here last week what I think is a very solid trade idea, so I don't see why I should be bashed just because the trade didn't work out yet
However there are some encouraging news from Dubai crude and I bet the producers will get a clue and stop hedging at these ridiculous discounts in summer months and the buyers will stop paying these crazy spot prices when the glut is imminent:
http://www.platts.com/latest-news/o...n-in-dubai-crude-narrows-on-upcoming-26567210
using the word riskless.... clues me in to the way your thinking.. There was nothing solid about that trade idea.. Alot more people will be helpful if you spoke with your humility, and asked questions, and didn't phrase things in statements as if you knew what you are talking about..