Lecture 20: Stock Index, Oil and Other Futures Markets

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Lecture 20 Stock Index, Oil and Other Futures
Markets
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Stock Price Index Futures

• Cash settlement rather than physical delivery
• Settlement is 250(Indext-Futurest-1)
• Fair value

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Lower Trading Costs on Futures vs. Spot Market
for Stock

• Theory of optimal bid-asked spread.
• Even though futures markets are not dealer
  markets, there is in effect a bid-asked spread,
  and it is narrower than for individual stocks.
• Less likely to be superior information to pick
  off dealers in stock index futures market than
  in market for individual stocks.

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Futures on Individual Stocks

• US ban on futures on individual stocks was fully
  lifted in December 2001.
• Trading in futures on individual stocks began at
  LIFFE (London International Financial Futures and
  Options Exchange) on NQLX LLC January 29, 2001
• US trading began 2002 at OneChicago LLC (owned
  jointly by CME, CBOT and CBOE)
• Volume of trade has been very disappointing,
  delisting is occurring

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Why a Market for Futures on Individual Stocks?

• In London, traders avoid the UK Stamp Duty
• In US, traders circumvent margin requirements on
  stocks. Final demise of margin requirements.
• Principal argument that accounts for US approving
  them is that foreign countries are now approving
  them, and US does not want to be left out.

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Oil Futures

• Crude light sweet oil (New York Mercantile
  Exchange) contract size 1000 barrels, open
  interest 431,000 contracts
• Brent crude, North Sea (International Petroleum
  Exchange, London) contract size 1000 barrels,
  open interest 232,000 contracts

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Nature of Oil Storage

• Most stored oil is moving through the pipeline
  of oil tankers, refiners, distributors and
  retailers.
• Estimated oil inventories can be found on web
  site www.api.com

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Government Oil Reserves

• Strategic Petroleum Reserve (created 1975) in
  caverns in Louisiana and Texas 572 million
  barrels, only 60 days supply. Not used to
  stabilize prices.
• In 2000, President Clinton established a 2
  million barrel heating oil reserve in New York
  and New Haven to help stabilize US heating oil
  prices. US consumption of heating oil about 100
  million barrels a year.
• Govt will sell from reserve when price triggers
  are hit. Effectiveness?

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Nationalizations of Oil

• Mexico 1938
• Iran 1951
• Cause resentment of foreign control, but
  justification was needed.
• Nationalization a 19th century word, OED says
  1874, socialist connotations.
• Eminent Domain is older word, does not seem to
  justify such expropriation of oil producing
  lands.

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OPEC

• Organization of Petroleum Exporting Countries
  established 1960 by Iran, Iraq, Kuwait, Saudi
  Arabia and Venezuela
• Qatar (1961), Indonesia and Libya (1962), Abu
  Dhabi (1967), United Arab Emirates (1974),
  Algeria (1969), Nigeria (1971), Ecuador (1973),
  and Gabon (1975)

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Optimal Extraction of a Natural Resource

• Problem facing a monopoly oil producer facing a
  downward sloping demand curve

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Solution of Extraction Problem with Constant
Demand Growth
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Fair Value for Oil Futures

• In this example, price rises at less than
  interest rate.
• Oil futures is below conventional fair value.
• Optimal strategy for non-OPEC oil producers?
• Other considerations extraction costs,

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Gold Futures

• Gold miners face same optimal extraction problem
  as oil producers
• If there are extraction costs, what is
  theoretical quantity of gold held above ground?

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First Oil Crisis, 1973-4

• Arab countries retaliation for US support of
  Israel in Yom-Kippur war 1973.
• Triggered sharp recession around world
• 1973-4 is second sharpest stock market crash in
  US history. SP Composite lost 53 of its real
  value between Dec. 1972 and Dec. 1974. (Only
  worse two-year experience was June 1930 to June
  1932.)

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Second Oil Crisis, 1979-80

• 1979 Iranian revolution, expulsion of the Shah
  of Iran, Ayatollah, capture of US Embassy
  hostages in Teheran Nov. 1979.
• Iran-Iraq war erupts 1980, disrupts oil supplies.
• US CPI inflation reaches 18/year in March, 1980.
• The great recessionof 1981-82 is the worst
  recession since Depression of the 1930s.

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Collapse of OPEC Cartel, 1986

• After suffering bombing by Iraq, Iran demands
  that Iraq be given the same oil export quota as
  everyone else.
• Other arguments about the disproportionate share
  of some OPEC states.

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Persian Gulf War, 1990-1991

• August 2, 1990, Surprise invasion of Kuwait by
  Iraq
• UN Security Council deadline for Iraq to withdraw
  by January 15 1991.
• January 16, 1991 Air bombardment of Iraq and its
  Kuwaiti positions begins.
• February 24, 1991 Allied ground invasion begins.
• War is over February 26, 1991.
• Brief interruption of oil supplies mark
  recession NBER dates July 1990-March 1991.

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Oil Price Collapse 1997

• Nov. 1997 OPEC Meeting, the disaster in Jakarta
  involved bitter disputes among OPEC nations about
  market share
• Fuming about widespread cheating in limiting
  exports to quotas
• Asian financial crisis dropped demand for oil

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Oil Price Spike 1999

• OPEC resolve to stop cheating left supplies
  shorter than they expected
• Erroneous data led them to underestimate how fast
  inventories were dropping.
• Backwardation in oil futures market (futures
  price below spot price) began in January 1999.
• OPEC Increased quotas

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Oil the Day Hussein Announces Embargo, April 8,
2002
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Natural Gas April 8, 2002
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Second Gulf War Oil Spike

• In anticipation of war, oil rises to nearly 36
  per barrel February, 2003
• US invaded Iraq, March 19, 2003
• Symbolic end of war after capture of Baghdad,
  crowd topples Hussein stature April 8, 2003
• Oil falls to 28 per barrel by April, 2003

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Federal Funds Futures Market

• Created by CBOT 1988
• Settlement price is 100 minus annualized federal
  funds rate, averaged over contract month.
• Show timing of expected actions of Federal Open
  Market Committee.
• One-month-ahead forecast errors typically in the
  ten to twenty basis point range.

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