CHAPTER 12

Crude Oil (Part 3), the crude oil contract

12.1 – The contract

Crude oil is the most actively traded commodity on MCX. The combined value of crude oil (across all contracts) traded on MCX, on average, exceeds Rupees 3000 crores on a daily basis. This translates to roughly 8500 barrels of crude oil traded daily. Active market participation in crude oil comes in from both corporate and retail individual traders. On any given day, you can expect both upstream companies (ONGC, CAIRN, Reliance) and downstream companies (IOC, BPCL, HPCL) placing orders on MCX. If I were to guess, these institutional orders are mainly to hedge their exposure in the spot (physical) market. On the other hand, the retail traders mostly speculate on the crude oil prices.

I’d encourage you to check the MCX ‘Bhav Copy’. This gives you a perspective on a particular contract’s liquidity and volume.

There are two main Crude oil contracts which are traded on the MCX –

  1. Crude Oil (the big crude or the main contract)
  2. Crude Oil Mini (the baby version)

In this chapter, we will learn how these contracts are structured – right from expiry to margins to P&L per tick.

m8-c12-cartoon

12.2 – Crude Oil, the big contract

With an average daily traded value of Rupees 2500 Cr, the big crude oil contract is certainly one of the biggest contracts (value wise) that gets traded on MCX.  Without wasting much time, let’s get straight to the contract details of the big crude.

The contract details are as follows –

  • Price Quote – Per barrel
  • Lot size – 100 barrels
  • Tick Size – Rs.1/-
  • P&L per tick – Rs.100/-
  • Expiry -19/20th of every month
  • Delivery units – 50,000 barrels
  • Physical Delivery – Mumbai / JNPT Port

Let’s understand this information in better detail. The crude oil on MCX is quoted on a per barrel basis (one barrel is equal to 42 gallons or about 159 liters). Have a look at the image below; this is the snap shot of Crude oil’s market depth –

image001

As you can see, the Crude Oil contract expiring on 19th Dec 2016 is trading at Rs.3197/- per barrel, quite obviously as we know price quote is on a per barrel basis.

The lot size is 100 barrels, which means to say that if you want to buy (or go long) on crude oil, the value of such a contract will be –

Lot size * price quote

= 100 * 3198 (offer price to go long)

= Rs.319,800/-

This is the contract value of the crude oil, but what about the margins? Unlike the margins on other commodities, the margin on crude oil is slightly higher. If you wish to carry the position forward overnight, then the margin requirement is roughly 9%.

This means, 1 lot of crude oil (100 barrels) requires a margin deposit of –

9% * 319800

= Rs.28,782/-

In fact, you can use the margin calculator on Zerodha’s website to get a ready reference of approximate margin requirement. Here is the snap shot of the same –

image002

The margin requirement under NRLM (for overnight position) is Rs.29,114/-, assuming the price of Crude is Rs.3,253/-. However, if you wish to make an intraday trade using MIS, then the margin requirement is roughly 4.5%. Clearly, as you can see from the snapshot above, margin under MIS is just Rs.14,557/-.

12.3 – Selecting the right contract to trade (expiry logic)

New crude oil contracts are launched every month. The newly introduced crude oil contracts have an expiry scheduled six months later. For example, the contract introduced in November 2016, will have its expiry in 6 months i.e., May 2017. MCX puts up this information regularly in their circulars, but I find it a little confusing to interpret the expiry table. Here is what MCX intends to convey –

Current month Contract Introduced Expiry on
November 2016 May 2017 19th May
December 2016 June 2017 19th June
January 2017 July 2017 19th July
February 2017 August 2017 21st August
March 2017 September 2017 19th September
April 2017 October 2017 18th October
May 2017 November 2017 17th November

And this is how the table in the circular reads –

image003

So, as I write this, its November 2016, which means to say the November 2016 contract must have been introduced in May 2016.

Anyway, the point to note here is this –

  1. Every month a new contract, 6 months in advance is launched (long dated contracts).
  2. These contracts expire on or around 19th of the expiry month, 6 months later.
  3. Given this, each contract lasts for 6 months in the market.

For active trading, always choose the near month contract. Now, assuming today is November 5th 2016, I’d choose the November 2016 contract expiring on 19th November to trade. Maybe around 15th or 16th November (as we progress closer to expiry), I’d shift to the December 2016 contract. The reason for this is simple. Liquidity is highest for the current month contract (November 2016 in this example). Liquidity picks up in the next month’s contract (i.e December 2016) as we move closer to the expiry of current month’s contract.

All the other contracts, even though exist in the market, pretty much lead a meaningless life, until they become current.

12.3 – The Crude Oil Mini contract

The Crude Oil mini is quite a favorite amongst the trading community. The reason for this is straightforward –

  1. The margin required is lesser
  2. The P&L per tick is lot lesser – did you know people prefer to see lesser loss than seeing higher profits?

Here are the contract details –

  • Price Quote – Per barrel
  • Lot size – 10 barrels
  • Tick Size – Rs.1/-
  • P&L per tick – Rs.10/-
  • Expiry -19/20th of every month
  • Delivery units – 50,000 barrels
  • Physical Delivery – Mumbai / JNPT Port

Have a look at the quote below –

image004

The Crude Oil Mini, December future is trading at Rupees 3,210/- per barrel. The contract value for this would be –

Rs.3,210 * 10

= Rs.32,100/-

The margin required in percentage terms is little higher – around 9.5% for NRML and 4.8% for MIS.

This puts the margin requirement for NRML at Rs.3,049/- and Rs.1,540/- for MIS. Clearly, way lower compared to the margin required for the big Crude oil.

Except for lot size, and therefore the margins, the other remaining features don’t change for both the crude oil contract contracts.

12.4 – Crude Oil Arbitrage

Have a look at the image below –

image005

The first part of the snapshot captures Crude Oil December future (big crude contract) along with its market depth. The second part of the snapshot captures the Crude Oil Mini December contract along with its market depth.

All else equal, both these contracts at the same time should trade at the same price. They are not supposed to trade at different prices, since the underlying is the same. In fact, this is what we notice here – both Crude oil contracts trade at Rs.3,221/-.

But, what if they don’t?

Let’s say, for whatever reason, both these contracts trade at different prices? For example Crude Oil is trading at Rs.3,221/- and the Crude Oil Mini is trading at Rs.3,217/-. Do we have a trading opportunity here? Yes, of course, we do have an arbitrage opportunity here, and here is how we can trade this.

Crude Oil – 3221

Crude Oil Mini = 3217

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

Trade Setup

We know the rule of thumb in any arbitrage trade – always buy the cheaper asset and sell the expensive one. So in this case –

We buy the crude oil mini at 3217 and sell the crude oil at 3221. However, please note, for a perfect arbitrage opportunity, we should always trade similar values.

The contract value of Crude oil is – 3221 * 100 = Rs.3,22,100/-

The contract value of Crude oil mini is 3217 * 10 = Rs.32,170/-

Given this, one should buy 10 lots of Crude oil mini at 3217 and sell 1 lot of crude oil at 3221. By doing so, the contract sizes are similar and therefore the arbitrage holds.

Once we execute this trade (efficiently), the arbitrage profit is locked in. Remember, in all arbitrage cases, the price will converge to a single price point. So assume the price finally converges to 3230 –

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

In fact, irrespective of where the price heads the 4 points are guaranteed.

It is unlikely you will find such sweet opportunities on a daily basis, and even if you do, algorithms grab them. However, I have occasionally witnessed such opportunities lasting for several minutes.

So do watch out for such trading opportunities, and if it indeed comes by, you know what to do.

This brings us to the end of our conversation on Crude Oil. Over the next few chapters, we will focus our attention towards ‘Metals’.


Key takeaways from this chapter

  1. There are two crude oil contracts available – Crude Oil and Crude Oil mini
  2. Both the contracts vary in the lot size. Lot size of the big crude is 100 barrels while the crude mini’s lot size is 10 barrels.
  3. Price quote is on a per barrel basis
  4. Every month new crude oil contracts are introduced which expire 6 months later.
  5. Expiry is on 19th of every month.
  6. The current month contract attracts maximum liquidity.
  7. Arbitrage between the two crude contracts can be executed – but one has to ensure contract values are similar.

45 Responses to “Crude Oil (Part 3), the crude oil contract”

  • RITUKANT MAURYA

    Its really refreshing course! Arbitrage Option is really wonderful.

    • Karthik Rangappa

      Thanks!

  • Khyati verdhan

    I really very much like this chapter, it’s very interesting.
    We are lucky to have a teacher like you.

    • Karthik Rangappa

      Thanks for the kind words 🙂

  • Prasanna

    Hi Karthik,

    I’m a fan of your writing especially the chapters on Options Strategies.
    Request you to kindly suggest books on options trading for enhancing my knowledge.

    • Karthik Rangappa

      Thanks for the kind words Prasanna 🙂

      Check out this book –
      Option volatility and pricing strategies
      Book by Sheldon Natenberg

      • Prasanna

        Hi Karthik,

        Thanks for the suggestions.After going through your text on Short strangle ,I have become more of a short seller.Nowadays I’m just writing Bank Nifty weekly expiry targeting 2% profit.

        • Karthik Rangappa

          Hope its working well for you. Good luck 🙂

  • anoop rawat

    hi Karthik,
    can you please tell if we trade crude in PI ?

    Thanks
    Anoop

    • Karthik Rangappa

      Of course, you can.

  • Khyati verdhan

    Hi kartik
    While using option calculator
    It asks for
    1) underlying price
    2) strike price
    3)Days to expiry
    4) annual interest rate
    5) implied volatility(call)
    6) implied volatility(put)

    From option chain I got IV(call) and IV(put)

    I want to know how to get annual interest rate.

    • Karthik Rangappa

      NSE assumes 10% annual interest rates.

  • Mehul jain

    Have u ever observe the diff in price of two month contract increses and decreases ??
    If u know why it happens how v can earn from dat please share

  • deepak

    Not related to this module.
    I read statements here n there that ‘this stock price will go up because of short covering’.
    In indian equity market ,we can not keep overnight position of shorted equity stock ,we have to square off it same day.
    Ofcourse for F&O we can keep overnight position.
    As Futures price is driven by underlying not vice-versa ,So I am confused how above quoted statement is correct. Why would undelying price would go up in upcoming days ? Why such statement is made up for equity stocks ?
    Recent Example: Crompton Greaves .

    • Karthik Rangappa

      Short covering is mainly used in the context of F&O. At times, F&O prices exerts its influence on spot…especially during short covering and long unwinding.

  • Abhishek Patil

    When crudeoil options are introduced in India & Zerodha ???

    • Karthik Rangappa

      I guess MCX introduced Crude oil when the started the exchange.

  • Vivek

    yet again you have explained these topics magnificently. Though this is off topic was just wondering if you can explain in another module or so abut INTRA day trading, about selection of stocks for intraday. Is there any book where one can refer for intra day trading and selection of stocks for intra day.

    • Karthik Rangappa

      Thanks for the kind words Vivek.

      We will be taking up trading strategies as a separate module soon.

  • Pratik Verma

    Today on 12th Dec 16, Crude oil Dec fut is @ 3473 and Crude oil Mini Dec Fut @ 3470 at 16:26, Is it a same trading opportunity ?

    • Karthik Rangappa

      Yes, provided you can efficiently capture all the 3 points.

  • raviraj445

    Thanks for the “Chapter on crude”…
    next chapter must be on “NATURAL GAS”.. 🙂

    • Karthik Rangappa

      The next one is on Copper and Aluminium. Should be up tomorrow.

  • Deepak

    Karthik, can you please recommend a good book which talk/analyses about Indian stock market history mostly 2000-2012 .
    I have many books about investing but they all carry US stocks examples . I am looking for a book in terms similar to “The Intelligent Investor” or “India After Gandhi” .

    • Karthik Rangappa

      Not sure about such books Deepak. Let me think through and get back soon.

  • Alok Kumar

    Thumbs up for Zerodha for Writing such Topics. Now a days brooking firms are taking only brokerage.

    • Karthik Rangappa

      Cheers!

  • Subbu

    Sir, if one executes the above arbitrage of 4 points in zerodha, say 1 big lot and 10 small lots. 4 points would result in a profit of 400rs. Out if this how much do the brokerage and taxes amount to? In other words, what is the minimum difference between crude big and small lots for arbitrage to be profitable?

  • Krishna.K

    hi karthik ,
    is the brent crude not traded in mcx (b’cos the quote is showing zero in mcx)
    Thanks&regards

    • Karthik Rangappa

      I’ve been told that MCX has withdrawn this contract.

  • Krishna.K

    Hi karthik,
    The expiry date for crude oil is19th of expiry month. Cash settlement can be done on 19th OR for cash settlement we have to square off the position 4-5 days before the expiry???
    Thanks&Regards

    • Karthik Rangappa

      Its best if you square off 4-5 days before. Else, you will enter the delivery obligation zone.

  • Rajat

    In last month, I did not know the expiry date being new to the commodity market. I had a open buy position in crude mini in the expiry date. I can not not find that position in the next day. Will there be any delivery obligation in future?

    Also can you please explain the significance of negative crude inventory data?

    • Karthik Rangappa

      I guess the contract would have been settled. Delivery obligation requires some sort of paperwork.

      Not sure about ‘Negative inventory data’. Are you referring to a situation where in the demand outstrips supply?

      • Rajat

        I am talking about the inventory data that comes every Wednesday. I see in some site the data is classified as “actual forecast and previous” columns. I interpret if actual no. Is less than previous then supply is less, more demand. But i don’t understand what a negative no. signifies there.

        • Karthik Rangappa

          I’m not sure, but if I were to guess, then the -Ve number could indicate a situation where the supply is lesser than demand.

  • Waahid

    Which is best advisory firm in india

    • Karthik Rangappa

      I believe the best advice comes from within, especially in markets.

  • Darshan

    Hello Karthik – If the open position is not closed on expiry day then one has to take the physical delivery of commodity or it is cash settled the way it happens in options. Thanks

    • Karthik Rangappa

      It’s cash settlement. But best if you can square off yourself.

    • Karthik Rangappa

      It’s explained in module 1.

      • Darshan

        Thanks for the clarification..!!

        • Karthik Rangappa

          Welcome!

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Copyright 2014 Varsity@Zerodha

Chapter 12 Currency & Commodity Futures
 
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