[elliekelly]

> Peterffy said there’s a problem with how exchanges design their contracts because the trading dries up as they near expiration. The May oil futures contract -- the one that went negative -- expired the day after the historic plunge, so most of the market had moved to trading the June contract, which expires May 19 and currently trades around $24 a barrel.

> “That’s how it’s possible for these contracts to go absolutely crazy and close at a price that has no economic justification,” Peterffy said. “The issue is whose responsibility is this?”

It’s pretty well known that commodity futures contracts are a game of hot potato for most investors as the expiration date approaches. But the Interactive Brokers CEO doesn’t offer an alternative solution. How would the contracts be structured instead that would avoid this? I don’t see how it would be possible.

[curiousllama]

The other issue here is that there IS an economic justification: everybody bid up the price of storage. If it costs me $60 to store a barrel I can sell for $10 later, then I'll pay someone $40 to take it off my hands now. An asset became a liability, hardly a rare concept to anyone who has owned a car they had to pay someone to tow away... CEO is just passing blame.

[elliekelly]

Interesting point. Have we commoditized and securitized the storage of commodities yet? Can someone purchase oil storage futures contracts to mitigate this risk?

[jldugger]

Go betweens exist and on Planet Money one was interviewed: https://www.npr.org/2020/04/22/842095406/episode-993-negativ...

Their website: https://www.thetanktiger.com

> The objective of the Tank Tiger is to serve as a clearinghouse and a single point of contact for parties who desire terminal tank services or utilization of midstream assets and to bring them together with the companies who own these assets and seek further utilization. It also provides for tenants who are leasing storage to find subleasing opportunities, when it makes sense for them to do so. Our expertise in this field provides a fast and efficient connection so that the uncertainty of storage availability is eliminated from the supply and trading equation. The Tank Tiger can facilitate and reduce market inefficiencies and illiquidity by providing this service.

[pathseeker]

Yep, but it's worth pointing out that this firm just connects you up with people and you have to deal with individual storage owners to buy something. Very high friction to firing up your brokerage app and going long /CL.

[darkwizard42]

I think there might be a market for that but probably not as formal as the trading of oil futures themselves. Basically a more private transaction on a marketplace that isn't as visible or as liquid as the futures.

[hchz]

OTC-traded contracts are just as formal. I’d say that these markets are generally more formal in practice due to the lack of retail actors who don’t understand the microstructure, sources of risk, or how to price their assets individually and across their book.

[bsdz]

You can buy FFAs

[akiselev]

I've only recently started learning about how trading works in depth so I'm probably way off, but isn't he just avoiding the obvious answer? The broker and the clearing house. I thought that's a large part of why we have them? It just so happens that counterparty risk includes handling of massive amounts of physical goods so they'll have to charge larger commissions to cover the additional risk on the contracts. It would probably reduce the number of speculators at the same time, reducing the risk of this happening to begin with.

[brazzy]

When the price mayhem was happening there was a discussion here on HN, and someone claimed that brokers would either never let retail investors handle contracts with physical delivers, or forcibly close the positions several days before the deadline.

Looks like Interactive Brokers fucked up in more than one way here.

[fludlight]

Don't know why you're being downvoted. Physical delivery IS a third rail for retail investors and brokers should absolutely have a field in their settings page that authorizes them to close the position x days or hours before maturity.

[andy_wrote]

There are ETFs that track oil futures (basically like a stock, but backed by oil instead of a company). It's been a while since I've looked at any of this, but I think USO is still the most prominent.

There are plenty of things to watch out for with these ETFs. You pay ongoing expense fees. And ETFs, especially those that aren't just holding containers for assets, can have subtleties in their prospectuses that cause their value to fluctuate in counterintuitive ways. There's still a lot to be cautious about.

However, compared to the actual futures, they're more suitable for casual investors, for reasons such as what we see here. They can't go below 0 and don't necessarily involve margin. And the ETF will typically deal with things like rolling the futures position ahead of expiry.

[haltingproblem]

Sorry but this is terrible advice. If trading Oil Futures is akin to playing Russian Roulette then trading Oil ETFs is akin to juggling live hand grenades. One will go off as soon as you stop!

Most commodity and leveraged ETFs are designed to benefit just one party - the designer of the ETF. There are plenty of articles on USO and its travails.

[andy_wrote]

I'm not recommending USO or oil itself as an investment, and I agree that you will be paying money to the ETF manager if you get involved in it.

But I don't agree that USO is _more_ dangerous for a casual trader to trade than oil futures, for the reasons I mentioned.

Removing the overall fluctuations of the oil market, the relative problem with ETFs is that they bleed away value over time. That's a real issue, but I wouldn't compare that to juggling a live hand grenade.

Edit: you did not say it was more dangerous, my mistake. I do think that ETFs are less dangerous, for the reasons I mentioned.

[tramtrist]

I owned USO and sold it on 4/21. I lost money of course. It seems USO could never go negative according to what you said and I could only go to 0 but I learned my lesson to stay out of futures for good

[jldugger]

If I just wanted a ticker symbol for the price of oil to put on a 'market health' dashboard, with no intention of actually investing in the ETF at all, would USO suffice?

[haltingproblem]

No. USO is not symptomatic of the health of the Oil market [1]. USO is a bizarre beast and any analogy fails to explain it. The only thing indicative of the health of the Oil market is spot and futures prices. [2]

This, unfortunately (or for some, fortunately) requires understanding the structure of the Oil market and how Oil is bought, sold, delivered and transported and yes stored! Spot prices, futures, oil grades, hubs, contango, etc.

[1] https://www.bloomberg.com/news/articles/2020-04-30/investors... [2] https://oilprice.com/oil-price-charts

[somebodythere]

You probably want the front month WTI and possibly Brent futures price.

USO has unpredictable drift due to contract rolling and often trades at a significant premium/discount to NAV.

[whatok]

> And the ETF will typically deal with things like rolling the futures position ahead of expiry.

This listed as making commodity ETFs more suitable for "casual investors" is the exact reason why they always lose money on ETFs. Retail investors for the most part do not understand contango or backwardation and do not understand (even though it's listed at the beginning of every prospectus) that these are not buy and hold instruments. In fact, I'd argue that it's easier to understand roll costs by actually having to roll futures contracts yourself (which is not difficult at all) vs having it obfuscated away in an ETF.

[kccqzy]

Definitely no. ETFs merely hide the fact that the underlying are futures contracts. ETFs make these futures contracts seem like stocks so any Tom Dick or Harry thinks they understand it and buys them. It's a very leaky abstraction.

> They can't go below 0

One month ago people know that futures can't go below 0. What guarantees ETFs will never go below zero? It's economically absurd to think an ETF holding negatively priced assets will still have positive value.

I would argue that if an investor isn't knowledgeable enough to trade an underlying, the investor shouldn't trade an ETF of these.

[andy_wrote]

The asset value underlying an ETF can be negative, but then the owner of the ETF will just have a worthless piece of paper. The ETF managers will have a problem on their hands regarding the negative amount, though.

In contrast, a futures contract is an agreement to make a future trade, so it can keep going against you past 0. If you are able to take physical delivery, your worst-case scenario is that you pay the money you said you would, and you get your oil. But if you are a casual day-trader type, you probably don't have the ability to take physical, so you may be in trouble (over a barrel, literally).

I agree with you about the dangers of ETFs and about knowledgeability. I didn't mean to advocate for ETFs on an absolute basis, just to make a relative statement about them vs. futures.

[tialaramex]

And as you'd expect ETF managers "fixed" this by shuffling things so that the "same" ETF is now backed by a different mix of futures they're less worried about.

My opinion is that ETFs are legalised bucket shops and ought to go away. The Oil Futures market represents an actual need, Alice wants to sell her oil knowing what she'll get for it when it's delivered in a week's time, Bob wants to be able to lock in today's prices for next week's oil. There is clearly a deal to be made there and if people who don't actually need oil want to tie themselves up in it and maybe improve liquidity I guess I won't stop them. But Oil ETFs are just a way to gamble on the value of the Oil Futures, and that's why we forbade bucket shops. Negative future prices show that the mechanisms which are supposed to make ETFs safer than bucket shops are flawed, and IMO too flawed to continue to accept them as a legitimate business.

[wpietri]

> It’s pretty well known that commodity futures contracts are a game of hot potato

Very much so. I wrote software for financial traders in the 1990s, and I heard tell of a couple of clerks (in this context, sort of "trader intern") who thought they were smart enough to do a little commodity metal trading on the side. However, they didn't quite understand the details of contract expiration, and so supposedly they ended up with 25,000 pounds of copper delivered to somebody's parents house. Oops!

[simonh]

There are contracts that specify physical delivery, but they also specify the warehouse or storage facility the commodity will be delivered to. The buyer can either collect the commodity or pay the storage facility to hold it for them. It's not likely it would be delivered to someone's house unexpectedly, because someone would need to pay for the additional cost of transportation.

[wpietri]

Yeah, the way the story was told the thought they could save some money and the hassle of making a deal with a warehouse. Why pay for something they're never going to use? So they agreed to pay for transportation in the event of delivery, thinking they'd never get charged for it. But I could well believe this was a trader urban legend.

[quickthrowman]

A source to back you up, this is precisely how it works. The CME link goes into more detail on how physical delivery works for base metals.

Other physically settled commodity contract have different delivery locations, /CL (WTI crude) delivery takes place at a terminal and storage facility in Cushing, OK.

https://www.cmegroup.com/education/courses/introduction-to-b...

[beerandt]

Oil and gas also have the benefit of published prices for most pipeline transport, although you still need a buyer/terminal that's physically connected to the network to take delivery.

[centimeter]

That's fake. Delivery doesn't work that way. The contract will specify one or a few acceptable delivery locations, always some industrial shipping depot or something.

[bsder]

It certainly could be apocryphal, but ....

I thought the commodity was coal. And the issue was that the trader was at a fancy new office park with a river view that was an old dock specifically for coal.

[fhars]

There is this old story in the same vein (and of course also [citation required]): https://thedailywtf.com/articles/special-delivery

[baking]

Sorry, but this story is utter bullshit. Source is unreliable and the only link in the story is to the movie "Trading Places" and the maybe the "WTF Stock Exchange" might be a clue.

[sulam]

Sounds apocryphal.

[wpietri]

Could be! It was definitely a friend-of-a-friend territory. But often legends of failure are used to warn against real dangers. Little Red Riding Hood is surely fictional, but wolves in the woods definitely weren't.

And at least in Chicago in the 1990s, traders and clerks could definitely be wild. During slow periods on the CME floor somebody would get a transparent trash bag, declare it a $20 bag, and then walk around with it. People would write their names on $20s and throw them in. Once they'd made the rounds, they'd shake the bag and have somebody draw from it. I myself saw thousands of dollars change hands like this. And clerks would regularly bet one another about jumping into the Chicago river from Upper Wacker, which is a fair drop.

Or there was one incident that was witnessed by a couple of our traders, as it happened in their pit at the CBOT. One afternoon among all the colored coats, they see somebody in a polar bear costume walking around the trading floor between the pits. One trader turns to another and says, "I'll pay you $100 if you punch the polar bear." The trader thinks about it, takes the $100, goes over, lays out the polar bear, and then in the chaos goes back to his pit. This turned out to be a bad trade, as the polar bear was there as a fundraiser for the Lincoln Park Zoo, and one of the people on the zoo's board was also on the exchange's board. Oops!

[aluminussoma]

Also told on Page 34 of Ron Insana's Traders Tales: https://books.google.com/books?id=NyeVNsWvJHAC&pg=PA32&lpg=P...

[wpietri]

Holy moly! Yes, that's exactly when I was working there. Glad to know there's some confirmation for that one!

[dmurray]

Everybody has heard of this happening to their friend's cousin's ex's colleague. In practice you can't trade futures without a broker, and your broker won't let you take futures to delivery unless you convince them you have the facilities to deliver or take delivery. And if you do take delivery of copper futures on the main exchanges (CME or LME), you get "warehouse receipts" which entitle you to turn up at some industrial estate and collect your copper, and which can be resold.

[wbl]

Financial settlement against a spot market in a large port.

[defen]

WTI (West Texas Intermediate, the one that went negative) is already settled at a specific place: Cushing, Oklahoma. Unlike with Brent Crude you can't just drive a tanker up to Cushing Oklahoma. So if you buy a WTI contract you are promising to take delivery of 42,000 gallons of oil there...it's the nature of the contract that there's no way around this.

[mathgenius]

ICE offers an equivalent cash settled contract, that takes it's value from CME's closing prices.

https://www.theice.com/products/213/WTI-Crude-Futures

[defen]

Right, but the reason it went negative is that there was no place to store the oil (demand for storage went through the roof because demand for actual oil plummeted). So that if you held one of these contracts, you had to pay someone to store your oil (directly or indirectly, if doing a cash-settled contract). If the people in the article did cash-settled contracts they would have been in just as much trouble.

[TuringNYC]

Curious -- did they settle at a price where holders had to pay up on the below zero spot?

[curiousllama]

Cash settled contracts exist. These people just chose not to buy them. The question is how to structure physically settled contracts. After all, oil needs to get delivered to someone at some point.

[AnimalMuppet]

If you get into the market for physically settled contracts with no intention of taking delivery, then you're almost certainly a speculator. I'm not sure that it's the market's job to make that safer for you.

I am not justifying inaccurate pricing. Burning speculators is fine, but give everyone accurate information.

[centimeter]

> If you get into the market for physically settled contracts with no intention of taking delivery, then you're almost certainly a speculator.

Hard disagree. There are lots of reasons people with legitimate hedging concerns who don't intend to take physical delivery prefer the physical contract to a CSC (if it's even available).

[AnimalMuppet]

Would you list some of those reasons, instead of just making the bare assertion?

[centimeter]

* Higher liquidity, lower slippage

* Different regulatory capital requirements

* Some commodities don't have cash settlement

* Sometimes a CSC doesn't count (as much) from a regulatory/insurance perspective if you're hedging a position in a commodities basket or whatever

I'm sure there are more - I don't work in commodities.

[TuringNYC]

These futures contracts are for delivery at a specific location. What if you just dont want a million barrels 2000 miles away? Cash settled seems a lot more flexible for lots of industrial use.

[vardump]

Or possibly someone who needs large amounts of oil and want to hedge against fluctuations?

Freight industry, airliner, etc.

[AnimalMuppet]

If you need large amounts of oil, then either you plan on taking physical delivery, so you can just let the contract expire, or you don't plan on taking delivery of that oil, in which case you want cash settlement contracts.

[thoraway1010]

Good lord, if you actually need the oil, then take delivery!

The issue here is total speculators using PHYSICALLY settled contracts to speculate who don't want delivery.

The number of people who need WTI are pretty few - refiners and some small others. Seriously - with WTI you still need to refine it - airlines CANNOT just load WTI into their tanks.

These sob stories from folks who supposedly were bidding to take delivery of physical oil (unrefined) from a condo somewhere are ridiculous.

To trade futures you need to certify you understand them. I'd love to see the form this guy filled out listing what was likely a fair bit of bogus experience.

I'm fine with all these idiots getting burned.

[CydeWeys]

Airlines buy futures in Jet A or Jet A-1. They have no interest in crude oil because they aren't refiners and they have nothing to do with it.

The freight industry will similarly buy futures in bunker fuel, diesel, or whatever exactly they use to fuel their vehicles. Again, they're not refiners and have no use for raw crude.

It's the oil refiners that buy futures in crude. Well, them and speculators.

[centimeter]

> Airlines buy futures in Jet A or Jet A-1. They have no interest in crude oil

It doesn't matter. Airlines absolutely buy crude futures to hedge against changes in fuel cost. It might be impossible to buy futures in the exact good you need, or it might be too expensive due to illiquidity and slippage.

It's like how beer manufacturers buy aluminum futures even though they almost never take delivery on the futures. They're just going to buy the processed aluminum from their regular processed aluminum supplier, but they can still hedge some of the price changes with the easily available physical aluminum futures.

[tempestn]

That would seem counter to, "with no intention of taking delivery," from your parent's comment.

[evanpw]

The contract is for a particular kind of crude delivered at a specific location. Most hedgers would still be better off closing the futures contract and taking the delivery they actually want instead.

[jgalt212]

It's far from a solved problem. Similar issues, albeit not quite as volatile exist for TBA mortgage bonds--except it's not usually problem of storage and more a problem of delivery.