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 daily. 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, retail traders mostly speculate on 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.

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 contact 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 -19/20^th 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 litres). Have a look at the image below; this is the snapshot of Crude oil’s market depth –

As you can see, the Crude Oil contract expiring on 19^th 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 snapshot of the same –

The margin requirement under NRLM (for an 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 contractor 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 –

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 19^th 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 5^th 2016, I’d choose the November 2016 contract expiring on 19^th November to trade. Maybe around 15^th or 16^th 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 the 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 favourite amongst the trading community. The reason for this is straightforward –

1. The margin required is lesser
2. The P&L per tick is a 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 -19/20^th of every month
• Delivery units – 50,000 barrels
• Physical Delivery – Mumbai / JNPT Port

Have a look at the quote below –

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 a 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 –

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, and 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 daily, 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 on ‘Metals’.

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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 the 19^th 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.