Futures Contract: Impact on Slick Oil's Profits
How does the market price of crude oil impact Slick Oil's profits?
Suppose that on February 27, 2015, the market price of crude oil is $65.50. How does this impact Slick Oil's profits?
Choose the correct option:
- Slick Oil suffers a loss of $65,000,000 from its contract with Gonzo Gas.
- Slick Oil suffers a loss of $1,000,000 from its contract with Gonzo Gas.
- Slick Oil suffers a loss of $500,000 from its contract with Gonzo Gas.
Answer:
Slick Oil and Gonzo Gas have entered into a futures contract. Slick Oil suffers a loss of $500,000 from its contract with Gonzo Gas.
A futures contract is an agreement between two parties to buy or sell a specific quantity of a commodity at a predetermined price on a specific future date. In this case, Slick Oil agrees to deliver one million barrels of crude oil to Gonzo Gas at $65 per barrel on February 27, 2015. On that date, the market price of crude oil is $65.50 per barrel.
As Slick Oil agreed to sell at $65 per barrel, it suffers a loss of $0.50 per barrel ($65.50 - $65) compared to the market price. To calculate the total loss, multiply the per-barrel loss by the total number of barrels in the contract: $0.50 x 1,000,000 barrels = $500,000.