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Trading Oil Options and Futures - Terminology and Process

By Edited Nov 13, 2013 0 0

The problem with how to trade oil options and futures is that it can be somewhat technically challenging for the first-time trader. Jargon such as futures, options, DMA chart, long buyer, short seller, strike price and ATM contract can be intimidating at first.

However, the mechanics of trading oil futures are relatively simple.
In fact, if you have ever traded stocks online before, you already have a good grasp of the basics of futures trading.Let's get through the terms first.

Both options and futures are simply a form of derivative contract, meaning their prices are based on an underlying instrument, such as oil like in this case.
You don't own the asset, but you can manage it allowing you to lose or make money as the price falls or rises on the market respectively.

The 200 day DMA (daily moving average) chart is an important technical tool used by professional traders in determining the trends of the market. A long buyer is the party agreeing to buy the underlying asset in the future, while the short seller is the party agreeing to sell the asset in the future.

The price level at which an options contract can be exercised is known as the strike price.
An ATM (at the money) contract is an options contract whose strike price will be closest to the price that the underlying asset is currently trading at.

Now, let's look at the mechanics of how to trade oil options and futures. First you will need to select a trader carefully based off of their credentials and qualifications. You should choose a person that the Futures Trading Commission certifies as a member.By scanning online stock forums you can find reviews of trading brokers by other amateur traders. These can help you to make a sound decision about who to trust with your money. 

You will need access to a 200 day DMA chart, such as the free one at Market Watch, so you can determine the current oil market trend.

You will use this chart to determine if you will be a long buyer if the market is trading above the 200 day DMA, or a short seller if the market is trading below it.To find the trend, draw lines across the tops and the bottoms of the price cart, creating a channel.

Now, stand back a couple feet and try to determine if the market trend is up or down, as you want to buy an oil contract at the channel bottom and short sell one at the top.
Once you've determined the trend, it's time to choose your options contract with enough time on it (at least 6 months) so it can move towards your price.

If you're not sure how to choose one, its generally best to select an ATM where its strike price is closest to where oil is currently trading. Finally, you should select a futures contract with the nearest expiration date, unless you have a strong reason to purchase one with a later expiration date.
For example, assume you purchase in May, then you should buy either a May or June futures contract because these will have the highest numbers of buyers and sellers providing a lesser bid/ask spread and will cost less.


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