Question

The price of oil fell to an unprecedented level during the Monday April 22nd 2020 trading session creating major disruption and fear among oil producers and traders. Give extensive answers to: 1. What contributed to the collapse in the oil price? 2. How did the derivative market facilitate that process? ( relate with futures pricing formula ) 3. What advice would you provide to oil producers for the next contract expiration?

Answer 1

1. Oil prices collapsed due to expectation of an impending recession and low demand and lack of supply chain management. While produces were unable to deal with storage cost and failure of OPEC to reach conclusion.

2. While May futures collapsed to an unprecedented level of negative levels because the of fears of uncertainty as while suppliers were unable to pay with storage cost. The USO also said that it will reduce the volume of may contract to an unprecedented level of 30% of previous expiry.

3. There is more loom and gloom in energy sector. oil prices may even slip furthur the due to the uncertainty strolling around the whole energy sector. One should hedge his position so that that would prevent any further erosion of the wealth of the downside. It can be done through taking out of the money put options of may contract.