Swaps vs Futures: the differences | Oil Trading | Brent | WTI | Crude | Petroleum

the simplest definition that I have for a swap for people don't really care to try and understand any more than that is it is a bet on the price of oil futures are key elements they're regulated they go through an exchange they're standardized now what does it mean that they're regulated and through an exchange it means that when you do a futures contract of futures deal the counterparty is the exchange itself so if I buy one lot of Brent futures maybe at the same time VTOL sold one lot do I know that it was VTOL no I have no idea I don't even care my counterparty is ice the Intercontinental exchange if we're talking about Brent it's a bad example because there's no physical delivery under Brent but let's go to WTI West Texas and to me intermediate nymex actually they were bought by the see me anyway nymex light sweet crude futures if I buy one lot of took January 2019 WTI futures that's 1,000 barrels so I buy one lot of it and hold on to it if I just hold on to it what's going to happen well I have a price risk but let's ignore that but can I hold on to that forever no it's for when is the delivery of the January 2019 futures contract for WTI it's in January because that's a January future so it means the delivery is in January sooner or later and probably some around the middle of the month of December I'm going to get a phone call who's gonna call me up I well in this case would be nymex or the CMA and say Chris you bought one lot of WTI yes I did well the contract has stopped trading it's expired there is no more trading of January futures Oh what does that mean you are now the proud owner of one thousand barrels of WTI in Cushing Oklahoma can you please tell us where you want it to go I don't have a tank what should I do okay if you screw up like that the exchange will try and find someone who screwed up the other way they'll find someone who sold and doesn't have the oil and then mixed you together and cancel it out but technically I will be receiving oil WTI in January physically in someone on the other side who sold one contract the exchange will match us together I'll get the oil he will deliver the oil there's no physical delivery under the Brent contract because nobody was willing to take the responsibility of organizing and make sure it worked everyone hope that she'll would do it and she'll sit not interested thank you very much so Brent looks like there should be physical delivery it expires prior to the month why do we expire that for example WTI why does the January WTI contract expire in the middle of December because we have to do we need time to organize the delivery could you have the con to January futures contract expire on the last day of January when are you going to get the oil in that case by the time you sort everybody out and match them together when will the oil be physically delivered February therefore it would be a February futures contract so the nominal month is the delivery month so that's what a futures contract is futures are very convenient because they tend to be small quantities a thousand barrels is very small so it's easy to deal with all right what's a swap I said earlier it's a bet I'll come back to that first of all a swap is what we call OTC never know what OTC Musil over-the-counter so it's unregulated we can do a swap with each other and we can do any sort of swap we want we could write it in Swahili we could carve it in two pieces of rock doesn't matter we could have it under Chinese law fine we can do whatever we want is that very convenient to do it that way probably not so much if you're trading a futures contract it's perfectly standardized every single futures contract for December for June for whatever is identical the only thing that changes is the price but an OT spot because it's over-the-counter we can do whatever we want with it all right most of the time people don't do that because if you buy a swap and then want to resell that swap if you have the contract written in Swahili and now you have to sell a swap to somebody else written in Chinese what happens if something goes wrong you might have price risk or legal risk or something so we tend to keep the same language but they're not regulated okay so that's what a swap is legally there's no physical delivery under swap which is why it said it's sort of like a bet so let's go back to this example we're talking about we're talking about December Gasol December Gasol prices in Europe Platts cargo prices you think they're going up I think they're going down the market has established a futures market a forward market through these prices so we can look at the mark and say okay the market thinks it's $600 for December what does that mean that means that plats delivery prices for Platts in December the market is saying it's worth $600 do you think it's going up I think it's going down so we're gonna take a bet on that so if it goes to 601 you make $1 if it goes to 599 I make a dollar based on the average of the month of December very typically we use a monthly average well do I pay you just one dollar it's that very useful how do we set the size of the bed well how do we price Gasol in Europe shekels per bushel u1 per liter dollars per ton okay so Platts publishes 600 dollars a ton 601 dollars a ton so if we make this bet we need to establish the size of the bet so let's do a bet for 5,000 tons which is a standard size for a swap so you think it's going up so are you going to buy the swap or sell the swap the price of the swap is $600 we established that's the starting point of the bet do you think it's going up so you buy the fixed price so we're now are you now long or short long you want the price to go up i sell the fixed price at 600 I'm short I want the price to go down and the size of the bet is 5,000 tons we get to the end of December we look at all the Platts prices over the month and it's six hundred two dollars who won and how much do I have to pay him he bought at six hundred I sold it six hundred of the fixed price so I was the the swap seller he was the swap buyer the settlement price is six hundred and two what was the size of the bet five thousand so I have to pay ten thousand dollars so when you think of this is just a bet on where plots will be publishing their prices it's an easy way to conceive of of swaps it eliminates this whole thing about wait a second my getting physical oil not getting physical oil it's just a bet on where prices are going paper so what we call our paper contract a derivatives contract now how is that useful how does that help us what are we worried about if we own a bunch of oil that we'll be selling in December suppose I have a cargo of oil that I'm setting in December using Platts castle prices what am i afraid of that the price in December will be lower and the price is published by Platts will be very low so what will I do will I still sell that swap will i buy the swap sell the swap I'm long oil I need to be short the swap so I need to sell the swap once I sell the swap for December for the same amount as my cargo 5,000 ton cargo 5,000 fun swap am I now hedged or not hitched I'm hedged I took the opposite position so my physical cargo I will sell using the Platts prices Platts Gasol prices I've bought it at $600 the market drops to $500 well I kill myself by throwing myself out the window or not but I was hedged so I lose $100 on my physical cargo and what about our hedge I sold my hedge at 600 and I get to buy it back at 500 so I make $100 here I lose $100 there and I've locked in that's $600 price same as the earlier example whatever price we agree to the hedge to the swap that's why I lock in my price okay so that's what a swap is again don't be confused that simply because a swap isn't called a futures that the price of a swap is a prediction any more than the futures price is a prediction it's not both are the price today for delivery in the future on a futures market there's actually physical delivery for the most part the swaps market it's a financial settlement but it represents what Platts prices and what a Platts prices represent physical cargos which are real deliveries

Channel: International Business House

Views: 14,558

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Keywords: Crude Oil, Oil Trading, Futures, Brent, Platts, Oil Products Trading, Swaps, ICE, Nymex, IBH, IBH Training, WTI, Trading Courses, Oil Trader, Oil Trader Academy

Id: jiPRYSMB2Tw

Length: 9min 54sec (594 seconds)

Published: Tue Aug 27 2019