Monday, April 20 was a special day in the markets. We saw negative crude oil prices. The price of May futures briefly touched -$40 a barrel. The close was about -$37. Alex Gilbert wrote a good thread about this on Twitter. A pdf version is at the end of this article.
In any futures market there are two kinds of participants. One group uses the futures market to hedge against price changes. The other far larger group is speculators. The first group will happily accept delivery of the underlying commodity if the price has moved in a direction favorable to their business. The latter group has no interest in the commodity at all. They are speculating on the price of the commmodity in the futures market.
Understanding Futures Markets
Understanding what futures contracts mean is important. Let’s consider crude oil. The price of a barrel of West Texas Intermediate crude oil is locked in when you buy a contract. In the parlance of traders you are “long oil” and have bought a contract. The flip side is being short oil. In that case you are obligated to deliver a specified quantity of the underlying commodity on a specific date at a given location (in this case, Cushing, OK). Each contract confers the obligation to either accept or deliver 1,000 barrels of oil on the expiration date. In this case, the contracts expire April 21. Speculators need to close out their contracts. Letr’s say you are long five contracts in this market. To close out your position you must become short five contracts. You are then obligated to deliver to yourself. You will default on this contract but neither you nor the commodity exchange will care.
Before continuing the example, let’s consider the underlying value of the oil. Assume a futures price of $5 per barrel. If you accept delivery of that oil, you will be asked for a $5,000 payment on the spot.
Apparently there were many more speculators long in oil than were short. Those that were long were frantically writing contracts and selling them at any price. Things then got very bad. There were no buyers. Eventually those who wrote the short contracts were literally forced to pay buyers to take them off their hands. Which is a lot cheaper than taking delivery.
Here are a couple of representative prices from late in the trading day.
Our pal Eddy Elfenbein weighed in with this quip.