Wednesday, October 1, 2008

Last week's oil spike

You remember how last week the price of oil spiked $25 on September 22 (closing up $15)? Don't read too much into that. When the media report on the price of oil, they seem to report on the spot price of the futures contracts with the soonest delivery dates. Contracts are for delivery on the first of the month. There are October contracts, November contracts, December contracts, etc.

September 22 was the last day to trade October contracts. Anyone who wanted an oil delivery for October had to buy that day. That magnified the normal market movement on that day. The contract for November went up by $6.62, which was a lot, but much less than the October one.

The price of oil isn't smooth because the market isn't smooth. There is a basic structure to the contracts to make them regular and consistent, and thus easier to trade. The down side of that is it introduces variables other than plain old supply and demand that have to do with the mechanics of trading and delivery. The oil market isn't the only market where such things happen, but that's where this phenomenon most recently manifested.

Credit to The Economist.

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