[zahma]

I'd greatly appreciate if any of you can explain how such a trade happened in layman's terms. Every time I try to look various vocab, I end up getting deeper into the glossary of hyperlinked words on investopedia and totally lose sight of the bigger picture.

[JumpCrisscross]

> how such a trade happened in layman's terms

Lots of functional market participants, e.g. oil refiners, don’t precisely time their trades. Their jobs don’t reward getting the best price at a given second. But they do reward getting cheap trades and punish getting the worst price in a day.

One solution is to trade at a standard future price. “Give me the closing price and a 50% commission cut” is a common order. In some markets it can be the dominant order type. That causes low liquidity during the day and lots of it at a single instance: the close.

These oil markets close at 2:30PM. Say a bank got an order, at Noon, to sell at the close $1bn of oil. It’s 12:01PM and oil is at $15. The bank could wait until the close and trade all $1bn. The bank makes its commission. But there is a risk the whole amount won’t be able to be sold at that instance. In that case, the bank would be left holding the bag for the balance. So it hedges.

At 12:30 it sells $100mm. This nudges the price to $10. The bank sells another $100mm. Price moves to zero. Bank sells another $100mm. Price goes to -$10. Bank sells another $100mm, thereby paying to offload oil. Price moves to -$20. By the time the close comes around, the price might be -$25. The bank pays its blended price, which may be -$10. But the customer paid -$25, so the bank makes 15.

In the equity markets, this is addressed with VWAP [1]. The volume weighted average price at which the stock traded during the day. More difficult to game. But more expensive to implement and thus execute.

[1] https://www.investopedia.com/terms/v/vwap.asp

[bko]

If I understand it correctly, you agree to buy something at a market price at a given time. Then you sell until that point, driving the price down and essentially exiting the trade at the same time.

Matt Levine from Bloomberg explained it.

Here are some excerpt

> One fairly technical explanation that we discussed was the “trade-at-settlement” mechanism. In oil futures, you can do a TAS trade in which you agree, at some point during the day, to buy or sell oil futures at that day’s closing price, plus or minus a few pennies. So at 11 a.m. you can agree “I’ll sell futures at 2:30 today, at whatever the settlement price is then.”

...

> Here is one really dumb simple way for that to work. You buy 1,000 futures via TAS during the day. You conclude that a lot of people are selling and no one is buying (except you). You think, well, okay, I have to sell 1,000 futures before 2:30, because at 2:30 I am going to get 1,000 futures at whatever the price is then. So you start selling. You sell 100 futures at $10, and the price goes down. You sell another 100 at $5. You sell another 100 at $0. You sell another 100 at -$5. Et cetera; you keep selling—into very thin liquidity, because there are not a lot of natural buyers—and the price keeps going down. By the time you are done, it is 2:30 and the price is -$37.63. The average price that you got, selling your 1,000 contracts, was, say, -$15: You started selling at +$10 and finished at -$37.63 and averaged your way down. But then at 2:30 you buy 1,000 contracts—the contracts you prearranged to buy using the trade-at-settlement mechanism—for -$37.63. You paid people an average of $15 to take oil off your hands, and people paid you $37.63 to take oil off their hands, and you made an average of $22.63 per barrel moving the oil.

[0] https://www.bloomberg.com/opinion/articles/2020-08-04/some-p...

[sukilot]

This seems to work regardless whether prices are positive or negative.

[bitlevel]

The film 'Trading Places' shows this in action (although they're trading on frozen concentrated orange juice prices and not oil).

Both entertaining and educational.

[novaleaf]

indeed. Planet Money did an analysis of the film's future trade, and it was indeed plausible and legal (then)

https://www.npr.org/sections/money/2013/07/09/200401407/epis...