Profiting from Oil Price Volatility

Submitted by Craig Strzelecki on 9 May, 2008 - 11:22

Oil Rig
So How do you profit from Oil Price Volatility?

Before the above question can be answered, it is noteworthy to say that oil price and the fluctuation happening in the US are interconnected in such a way that the extensive range of supply and demand driven independently has a big impact on the crude oil price.

Because of the above statement, the decline in the US dollar will cause a rising pressure on the crude oil price and the same thing goes for the US currency being pressured much by the crude oil price.

While the above observation was based on the principle and belief that the issues about supply and demand are always equal, it is still important to know that there are many reasons and factors affecting the above observation. However, there are two main considerations that are believed to play an essential role in this connection.

It was heard on the news on radio and TV and it was read on the newspaper that because of the effects of the fall-out of the sub-prime mortgage and the bad effect of the USA's position on its fiscal policy, the USA currency has had a rampant downward movement recently. This situation has caused an impact in the price of the crude oil. To explain this further, the weaker the US dollar becomes, the lesser cost of oil the countries with strong currencies have to pay for their imports. Some of the countries with strong currencies are European countries, Canada and Australia. When this happens, the demand for fuel becomes higher and this is causing much pressure on the oil price.

One more thing that creates the connection between the prices of crude oil and the US dollar fluctuation is the futures markets activity.

The sudden drop in the US dollar has attracted many investors to invest on the futures contracts for crude and they use this as precautions against the effect of the US dollar fluctuation. Moreover, the futures contracts for crude were also used to make the US dollar denominated future cheaper for those who are using the other currencies in their trading. Weighing this equally, because of the US sub-prime mortgage crisis, the financial market all over the world was shaken and as a result, the oil futures market has received more capital from many investors who were becoming so cautious with the risks coming from the stock market commotion. As a result of the increase in the oil futures demand, the price is also very much affected.

However, any investors who purchased a warrant may benefit from the crude oil movement. By purchasing a warrant, the investors are allowed to access the global commodity market with two simple steps involved. First, the time frame must be determined as well as the position of the commodity market chosen by the investor should be taken. This depends on the assumption of the investor that market price will either go up or go down. The investors may benefit from this in such a way that the warrant serves as a leveraged investment. It can be compared to a CFD that can deliver quite significant growth on the upside. However, unlike the CFD, the warrant does not provide a margin call and the investors are not allowed to lose more than the amount they initially invested.

From the above information, one can see that there are in fact many ways that commodity prices may be affected by a foreign currency. This is especially true when some investors use the situation to settle off from the instability derived from the foreign exchange markets. To understand this situation the simplest way, one may need to consider the current happening on the US currency that is causing the demand from nations with stronger currencies to increase and consequently may lead the price to increase. While it is true that the use of structured products like warrant plays an important role in the connection of fluctuating currencies, it is still important that other factors that play in the law of supply and demand be considered.