Module 8 Currency & Commodity Futures

Chapter 12

Crude Oil (Part 3), the crude oil contract

112

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.

112 comments

  1. RITUKANT MAURYA says:

    Its really refreshing course! Arbitrage Option is really wonderful.

  2. Khyati verdhan says:

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

  3. Prasanna says:

    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 says:

      Thanks for the kind words Prasanna 🙂

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

      • Prasanna says:

        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 says:

          Hope its working well for you. Good luck 🙂

          • Abhishek kumrawat says:

            Sir please tell me , how to rollover current contract to the next month contract in crude oil . Not cleared

          • Karthik Rangappa says:

            Rollover is just about closing the contract that you hold and initiating the position in the next month contract. For example, if you hold a long Crude position in Oct series, then rollover is squaring off Oct Contract and buying Crude in Nov contract.

  4. anoop rawat says:

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

    Thanks
    Anoop

  5. Khyati verdhan says:

    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.

  6. Mehul jain says:

    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

  7. deepak says:

    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 says:

      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.

  8. Abhishek Patil says:

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

  9. Vivek says:

    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.

  10. Pratik Verma says:

    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 ?

  11. raviraj445 says:

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

  12. Deepak says:

    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” .

  13. Alok Kumar says:

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

  14. Subbu says:

    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?

  15. Krishna.K says:

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

  16. Krishna.K says:

    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

  17. Rajat says:

    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 says:

      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 says:

        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 says:

          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.

  18. Waahid says:

    Which is best advisory firm in india

  19. Darshan says:

    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

  20. Anirban says:

    Are the commodity chart that are available continuous charts or expiry based charts in kite?

  21. Saida Rao says:

    Hi Karthik,
    Why crudeoil futures from one month to another month are at premium? How the fair premium for rollover can be calculated?

      • Saida Rao says:

        Hi Karthik,

        The link you provided explains theoretical futures pricing in general. I would like you to explain how the crudeoil futures month to month premium is calculated. Thanks in advance.

        • Karthik Rangappa says:

          Its not theoretical. Its the actual formula traders use. Premium or discount is a outcome of demand and supply, not sure of this is quantifiable.

      • Dipesh Ikhe says:

        Hi Karthik,

        I need help on this urgently, i have bought 30 lots of CRUDEOILM17AUGFUT and the expiry for that is 21st August but i am in loss at the moment, with just two days to go how can i rollover the Aug contact to Sept one, please guide me, thank you in advance for the help.

  22. Alok says:

    Hi karthik,
    Excellent explanation, as usual
    I have been trading in stock market for the last 3 -4 years. But I had zero knowledge about commodity trading (before reading of these module).
    I was never interested in commodity because there is no option trading
    But I have heard SEBI is going to start options trading in commodity, please let me know in which commodity options trading will be started.
    Thanks

  23. JSree says:

    Is short selling allowed in commodities trading?

  24. Kushan Joshi says:

    Hello Karthik,
    If the two crude oil contracts are trading at the same price because they depend on the same underlying, why is it not the same with other commodities too?
    For example GOLD and GOLDPETAL.

    • Karthik Rangappa says:

      Gold prices vary depending on the purity of the metal, suggest you check the contract specifications.

  25. Sandeep kumar says:

    Thanks sir for such a explanatory materials
    I have two Doug’s
    1:- while trading crude oil volume on minute chart shows 504 units as the lot size is of 100 barrels is it 50400 barrels or only 504 barrels.
    2:- volume for crude oil on minutes chart on 12/06/2017 15:48 shows 504 and crude oil mini shows 519 units,. Suddenly after three minutes at 15:51 volume of crude oil jumps to 5.19K and crude oil M jumps to 4.80K. my question is how in a single minutes institutional buyers come in both contract at a same time. Please explain as it happens all the time in both contracts

    • Karthik Rangappa says:

      1) Its 100 barrels. Are you using Pi for this?
      2) This could be purely co incidental – maybe an institutional client has placed a huge order.

  26. Ashok says:

    When compared with Index futures like nifty and bank nifty, commodity futures have very low number of Open Interest. Of all commodities only Crude oil and Nickel has decent Open Interest but still far low when compared with Nifty futures. Is it worth to trade?

    • Karthik Rangappa says:

      Well, OI is just a reflection of the liquidity in the scrip. What you need to ascertain is if you have enough liquidity for your trading size For example if you want to buy 10 shares out of the total 1000 shares, then you do have ample liquidity. However, if you want to buy 500, then it may not be a good enough.

  27. Ashok says:

    In previous comment you specified i need to square off before 5 days else i will enter delivery obligation zone. What is meant by that? Do i face any problems if i keep my position open till expiry? Please explain.

  28. Muthu says:

    Hi Karthik, Thanks for the wonderful explanation.
    Can you please let me know the ZD MIS timing (by what time will the trades be Auto squared) for MCX Commodity Trade, given that the market timings is from 10:00 am to 10:30 pm

  29. Amarendra says:

    Say i bought a stock crudeoilm today at 2917.
    1) Is crude oil traded world wide at same price?
    2) If yes for above, crudeoil is traded after 11.30 pm in usa almost all day. What if the crude oil market goes down by the start of tommorow market?
    3) Can i short and carry it forward to next day using NRML?

    Some understanding on these will help in going long or short on a commodity.

  30. vasant goel says:

    does the same arbitrage principle hold true for Gold and Gold M contract also since underlying asset gold is similar.
    today gold aug contract is 28156 and goldm aug contract is trading at 28170

  31. Mahesh says:

    Do you really think IOC and Reliance hedge on MCX??

  32. AARB says:

    Hello Karthik,
    Thank you for these detailed articles on Versity. I trade Crude Oil and Natural Gas contracts through Zerodha. I have the following questions for you:
    1. Since I trade multiple times a day, I exclusively trade current month contract. Since crude oil and natural gas contracts are settled in cash and also zerodha does not allow its clients to take delivery on MCX; is there any risk of physical delivery situation in crude oil, crude oil mini, and natural gas contracts under any circumstances?
    2. We had problems on Monday on the NSE, suppose MCX faces some problems and remains shut for the rest of the day on an expiry day of Natural gas or Crude oil contract. What will be the penalty levied on traders? And how it is going to be calculated? In this extraordinary case will it be a physical delivery settlement or normal cash settlement?
    3. Suppose overnight market gaps big, a trader needs to bring additional cash the next day. Are there any penalty and how much, if any, if short on overnight margin on MCX?
    4. ITM option exercised by NSE leads to ‘STT Trap’, are there any huge tax risk when future contracts get exercised by MCX?

    • Karthik Rangappa says:

      1) Not really as long as you ensure your contracts are squared off at least 5 days before the expiry
      2) If the problem is from the exchange side, then most likely the trades will be considered null and void and you will have another trading window to settle the trades
      3) Depends on the movement
      4) Nope

  33. Shakeel Hassan says:

    Sir, what the term “quantity” means in the market depth window. Does it means no. of shares or no. of lots. As in bids column first quantity is 98. Does it mean 98 lots??

  34. KRISHNAKAT KAREKAR says:

    Thanks Karthik you had exactly the information i wanted.,, Thanks

  35. Nan says:

    Sir,
    We hold position. What happens on the contract end day.

  36. Suraj Patel says:

    ONE Suggestion For Every Trader Needs……..Hope Understand.
    Pls pls pls work on price alerts in Zerodha Kite.. Kite has like everything, just for this 1 feature. @nithin

    I m waiting for this feature. this will b a great help for part time traders/investors as u dont need to watch ur stocks every now n thn. right now price alert available with IIFL mobile app.(Just for Suggetion) but waiting for kite app to update this feature.

    Example :- Buy Crude Oil @ 3100
    Target 3110
    SL-M 3090

    Then I set alert Both Target & SL. If 1st Comes Target then I cancelled SL-M Order OR if SL-M Comes I cancelled Target Order.
    Get Notification on Kite App && Kite.Zerodha.com. See IIFL App Price Alert Features…..
    Please Add This Feature for me kind of Busy Trade who don’t live whole days.

  37. Suraj Patel says:

    Hello Sir,

    I want to use different in chart & Want to back test it…..
    BUT in Zerodha Kite Chart Only Current Series chart data is available…..

    Need Crude Oil Chart Data for 5 to 7 years with 5 Min. To 1 Hour & EOD all data….. For Back Testing….
    Suggestion:- Can you please suggest me Good Software for Crude Oil Back Testing or Accurate chart candle data last 5 to 7 years with 5 minute to 1 hour & EOD data also….

    • Karthik Rangappa says:

      I’d suggest you check Pi.

      • Suraj N. Patel says:

        Hello Sir,

        I want to use different in chart & Want to back test it…..
        BUT in Zerodha Kite Chart Only Current Series chart data is available…..

        Need Crude Oil Chart Data for 5 to 7 years with 5 Min. To 1 Hour & EOD all data….. For Back Testing….
        Suggestion:- Can you please suggest me Good Software for Crude Oil Back Testing or Accurate chart candle data last 5 to 7 years with 5 minute to 1 hour & EOD data also….

        ” How to Check in Pi” –

        “I’d suggest you check Pi.” – Karthik Rangappa says: ????

        Process to Use Pi for Crude Oil Last 5 To 7 year data in 5 min, 15 Min , 1 H, 4 hour, daily etc…. Differance time frame. Pls suggest me Urgent Pls.

  38. Naman says:

    It’s better to square off normal position 5 days before expiry but can we do intraday trading even 1 day before expiry without having to worry about delivery obligation ?

    • Karthik Rangappa says:

      I’d suggest when you are close to expiry, trade the next month contract.

      • Ayush Upadhyay says:

        Sir if we trade intraday on the last 5 days before expiry what will happen? Does the physical delivery mean that we will actually be given oil barrels!?
        Also if we have to trade in next month’s future are the volumes sufficient usually?

  39. Vilesh says:

    Today 14th Sept 2017 I am trying to trade on CRUDEOILM17NOVFUT but was not able to trade. why are we not able to trade in 2 month ahead contract

    Please help

    Vilesh

    • Karthik Rangappa says:

      Nov contracts are illiquid and have large spreads. For this reason, at any given point, we allow only current and next month contracts to trade.

  40. vemuri nagarajan says:

    Sir,

    Could you please explain me how to roll over Oct.17 cont. in crude oil mini to next month. I have to pay any extra amount or I have to take physical contract by paying full amount. Pl. explain me about roll over procedure and cost involved in it.

    • Karthik Rangappa says:

      If your objective is to continue holding the same position for the next available contract, then simply close this months contract and buy the Nov contract. This is rolling over.

  41. vemuri nagarajan says:

    Can I hold short position in crude oil till expiry?

  42. Sandeep says:

    When are u planing to allow Bracket order in commodity

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