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Note on Crude Oil and Crude Oil Derivatives Markets Case Solution
The study provides in-depth knowledge of the crude oil market in the context of trading while using various derivative contracts. In the '70s, the spot market was dominated wherein major oil trading was executed in large physical cargoes or parcels in one-off transactions for near-term delivery. However, deregulations played a critical role in the development of future markets which came into being to counter the instability in the spot prices. In this regard, it is important to understand the key distinction between following derivative markets.
Following questions are answered in this case study solution
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Spot trading & forward trading
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Exchange traded derivatives & over counter (OTC) derivatives
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Contango & backwardation
Case Analysis for Note on Crude Oil and Crude Oil Derivatives Markets
1. Spot trading & forward trading
Spot trading of oil involves immediate delivery or lifting at a specified delivery point at the current market rate. The informal network of traders is involved through telexes and telephones and can trade one cargo many times before delivery to the final user. On the other hand, forward trading is a solution to the uncertainty in the spot prices whereby a specific quantity of oil with a predetermined price for a specific period is locked between two parties (i.e., buyer & seller). For this purpose, the most popular forward market was the UK Brent market which was a benchmark crude oil blend. Two types of forwarding contracts include dated delivery contracts (spot transaction with delivery within a specific date range) and fifteen-day delivery contracts (forward transaction with delivery at a specific time in the future). These contracts were traded for delivery up to 3 months with few actual physical deliveries.
2. Exchange traded derivatives & over counter (OTC) derivatives
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