Suppose Chad believes that the price of oil will be higher in the future and buys an oil futures contract from Joe. The contract will give Chad the right to 1,000 barrels of oil at $50 per barrel to be delivered by Joe 30 months in the future. Which of the following statements is correct?
A) Chad has to pay Joe $50,000 upon the purchase and waits for 30 months for delivery of 1,000 barrels of oil.
B) Chad will receive the cash difference from Joe if the per barrel oil price rises higher than $50 after 30 months.
C) Joe will receive the cash difference from Chad if the per barrel oil price rises higher than $50 after 30 months.
D) Joe will deliver the oil to Chad after 30 months and receive $50,000 from Chad.

Question

Quizplus · Accepted Answer

When Chad buys an oil futures contract from Joe, he is essentially buying the right to purchase 1,000 barrels of oil at a fixed price ($50 per barrel) to be delivered in the future. Chad does not have to pay the full $50,000 upon purchase, but instead will likely have to put down an initial margin (a percentage of the total cost) and may have to further margin calls. After 30 months, if the price of oil is higher than $50 per barrel, Chad can either take delivery of the oil or sell the contract to someone else for a profit. If the price of oil is lower than $50 per barrel, Chad will lose money on the contract. Joe, as the seller of the futures contract, is obligated to deliver the oil if Chad chooses to take delivery. If Chad chooses not to take delivery, Joe will settle the contract by paying Chad the cash difference between the futures price and the actual market price on the delivery date. Therefore, the correct statement is that Chad will receive the cash difference from Joe if the per barrel oil price rises higher than $50 after 30 months.

Suppose Chad Believes That the Price of Oil Will Be