My knowledge on Futures Trading is minsicule.Constructive criticism and alternate view points are most welcome.

Reams and Reams of Paper have been used up to paint a story of Oil Guzzling India and China as the main reasons behind the increase in the price of oil. If u have the habit of watching news channels then again ur opinion would not be any different. How True a Statement is it though?

Futures Market:

Introduction:

For benefit or readers who dunno what a Futures market is( guess most of them will be knowing about it). It is a place where an agreement is made between the parties to buy at a particular price on a Future date. To give an Illustration( am not happy with my definition), let say that u have 10 litres of oil with u, i need 10 litres for the next month, now i would want to secure my supplies for the next month and i am afraid that it might go up.So i enter into an agreement with u by which i agree to buy the oil at a price of say Rs 10 per litre( when the current market price is say Rs 8.50 paise per litre). Now if Oil shoots beyond Rs 10 i save my money and if it does not and goes down i lose my money.

Now what if i feel if the price of oil will go down to say Rs 6, i go ahead and make a sell agreement and sell Oil for say Rs 8 and if it comes to Rs 6 i go ahead and buy it back. Now my profit in this case will be Rs 2 per litre.

Time Bound Contracts:

All these contracts are time bound say 1 month, 2 months and these contracts can be extended, called as Roll Over in Futures market parlance. This extension cannot be beyond a particular time frame ( which i guess is 6 months or 1 year max).

Payment Terms:

There is no need to pay the entire amount when u enter into the contract. U need to pay only a percentage say 5 or 10% of the total contract. At the end of the contract if u want to buy the oil physically u can go ahead and pay the balance amount or if u want to make the transaction completely notional u go ahead and sell the contract and take the difference or pay the difference depending on whether u made profit or loss

Why Futures Market?

This market was originally evloved as a means to hedge ur portfolio against losses in the primary markets. Since these Futures are based on the primary markets they are also called as Derivatives.

Why about Futures Market here?

Futures which was originally conceived as something of a Hedge Tool, slowly became a Income generating option thanks to the brains in the Wall Street who managed to get as many commodities as possible under the gamut of Commodity trading.

Now the point to be noted is that none of the big Wall Street banks nor the Big shots who trade actively in Futures market actually take delivery of the stocks. They stick themselves to the notional buying and selling. Which means if there are more of such speculators who believe that Demand is going to go up and they pump money into the market, the price of Oil actually rises without even a single barrel beng bought or sold Physically(!!!)

What is Happening Now?

US through its mind blowing policies gave these speculators a great chance to have a field day, Everytime a bomb exploded in Bagdad or Saudi the price of Oil Shot up. Rather we can say that these speculators drove it up. India and China stories were used as camaflogues. When the prices went up the Oil Producing Nations thought of holding back supplies to increase profits,which gave the speculators reason to push the price again. More the prices went up the more these Oil Countries reduced to increase the supply, the more they did that the more the prices were pushed.

This vicious circle has resulted in Oil Trading at 145 Dollars per barrel (at the time of writing).

What needs to be done?

So what needs to be done? can we go ahead and ban the futures trading in Oil? Just because people are misusing it, it does not mean the system is bad. We need to fix the excesses of speculators.

The sad thing however is that it does not seem possible since the parties involved in this are Too Big for any rule to be applicable to them. So it seems like that the prices will continue to move up and we are in for some tough times.

P.S: It is not that these traders came into the scene all of a sudden, they have been there for years but it is just that they found the conditions conducive for them to ply their trade around, thanks to...Is there any need to mention the name???