Heating Oil Futures and Options

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The market for heating oil, also known as No. 2 fuel oil, grew rapidly after World War II, as homeowners and builders switched from coal. For decades prices were relatively stable, reflecting the worldwide stability of crude oil prices.

In the early 1970's, the market situation changed. As the government of foreign oil producers nationalized their crude oil reserves, and following the Arab oil embargo of 1973, price stability gave way to volatility throughout the petroleum industry.

With the lifting of U.S. price controls on heating oil in the mid 1970's, the New York Mercantile Exchange (NYMEX) began developing a heating oil futures contract and, in 1978, introduced the world's first successful energy futures contract.

Heating Oil accounts for almost 25% of the yield of a barrel of crude, the second largest "cut" of the barrel after gasoline.

In its early years, the NYMEX Division heating oil contract mainly attracted wholesalers and large consumers of heating oil in the New York Harbor area. Soon, its use spread to geographical areas outside of New York and it came apparent that the contract was also being used to hedge diesel fuel, which is chemically similar to heating oil, and jet fuel, which trades in the cash market at a usually stable premium to NYMEX Division heating oil futures.

Today, a wide variety of businesses, including oil refiners, wholesale marketers, heating oil retailers, trucking companies, airlines, and marine transport operators, as well as other major consumers of fuel oil, have embraced this contract as a risk management vehicle and pricing mechanism.

Who Uses the NYMEX Division Heating Oil Futures Contract?

The NYMEX Division heating oil futures contract can help most sectors of the oil industry -- refiners, wholesales marketers, and retailers ---take advantage of market opportunities or meet the challenges presented by ever-changing conditions in the physical market.

Full-service fuel oil distributors are active users of the heating oil futures and options contracts. Typically, a full-service dealer will protect a portion of his winter delivery commitments through the purchase of Exchange-traded futures and options. This enables a fuel oil dealer to offer a "guaranteed" delivery price, where customers are assured a set price for their annual consumption of fuel prior to the beginning of the winter season. The fuel oil dealer hedges these guaranteed price agreements by purchasing Exchange futures or options contracts, or by purchasing a wholesale supply deal which ties terminal cash prices to Exchange futures prices.

Wholesalers also use the NYMEX Division heating oil futures and options contracts to protect physical inventories and to hedge forward purchases of barge or pipeline supply.

Large commercial users of heating oil and transportation fuels use the NYMEX Division heating oil contract to hedge against increases in the cost of diesel fuel, jet fuel, and No. 2 fuel oil. Outside of the oil industry, a wide variety of businesses, including trucking companies, airlines, marine transport operators, and other major consumers have embraced the contract as a risk management vehicle for pricing, budgeting, and hedging distillate fuel.

Seasonal and economical factors influence the relative prices of heating oil, gasoline, crude oil, natural gas and propane. To help manage risk, market participants can trade NYMEX Division heating oil through NYMEX ACCESS^sm, the Exchange's after hours electronic trading system. The system is available five nights a week, Sunday's through Thursdays, during hours that the trading floor is closed. Workstations are available throughout the United States; London; Sydney, Australia; and during the first half of 1997, Hong Kong.

Traders can also use the NYMEX Division heating oil and gasoline contracts in tandem with crude oil futures to lock in the "crack spread" or theoretical refining margin.

 As a protection of falling cash market prices, producers, traders, and marketers can sell futures to lock in prices for future delivery, and thus, protect the value of future heating oil sales.

Since NYMEX Division heating oil futures are traded over 18 consecutive months, traders can implement hedging strategies that encompass two winter heating seasons.

Options Defined

The NYMEX Division heating oil options contract, introduced in 1987, complements the futures contract and provides yet another hedging instrument for market participants to increase their flexibility in managing their business risk.

Options can be used independently or with futures to create hedging strategies to fit any risk profile or cost consideration.

The holder of an option has the right, but not the obligation, to buy or sell a futures contract at a specified price at a specified time, in exchange for a one time payment, or premium. The seller of an option, on the other hand, has an option to buy or sell a futures contract, if a holder of an option chooses to exercise it.

There are two types of options: calls and puts. A call gives the holder the right, but not the obligation, to buy futures at a specific price (the strike or exercise price) for a specific period of time. A put gives the holder the right, but not the obligation, to sell futures a specific price for a specific period of time.

Buying a call or put is similar to purchasing an insurance policy: in return for a one-time up premium, the buyer obtains protection against the occurrence of risk for the designated time period. To protect against the risk of a price increase, a hedger would purchase a call; to protect against a price decrease, a put.

If prices do not move in an adverse direction, the options buyer forfeits only his premium and is otherwise able to participate fully in any favorable price move.

An options seller (or writer) performs a function similar to that of an insurance company. He collects the premium and is obligated to perform, should the buyer exercise the option. If the options contract expires without being exercised, the option seller profits by the amount of the premium.

Disposing of Options

Unlike futures, which must either be liquidated or held to delivery, the holder of an option has a third alternative: if the futures price does not move enough to make exercising the option worthwhile, or moves in the opposite direction, the buyer can choose to allow his option to expire without value.

24-Hour Market Information

The New York Mercantile Exchange public information office makes information available to the public 24 hours a day through Fastfacts, a state-of-the-art phone system that puts you in touch with vital Exchange information faster than ever. Statistics such as price and volume data are updated every five minutes by the Exchange mainframe computer. New information is available within 30 minutes. Call Fastfacts at (212) 301-4871.

Fastfacts access codes for NYMEX Division heating oil futures and options are:

NYMEX Division Heating Oil Futures and Options

Contract Specification

Trading Unit
Futures: 42,000 U.S. gallons (1,000 barrels).
Options: One NYMEX Division heating oil futures contract.

Price Quotation
Futures and Options: In dollars and cents per gallon: for example, $0.7527 (75.27¢) per gallon.

Trading Hours
Futures and Options: Open outcry trading is conducted from 10:05 A.M. until 2:30 P.M.

After hours futures trading is conducted via the NYMEX ACCESS® internet-based trading platform beginning at 3:15 P.M. on Mondays through Thursdays and concluding at 9:30 A.M. the following day. On Sundays, the session begins at 7:00 P.M. All times are New York time.

Trading Months
Futures: Trading is conducted in 18 consecutive months commencing with the next calendar month (for example, on January 2, 2002, trading occurs in all months from February 2002 through July 2003).

Options: 18 consecutive months.

Minimum Price Fluctuation
Futures and Options: $0.0001 (0.01¢) per gallon ($4.20 per contract).

Maximum Daily Price Fluctuation
Futures: $0.25 per gallon ($10,500 per contract) for all months. If any contract is traded, bid, or offered at the limit for five minutes, trading is halted for five minutes. When trading resumes, the limit is expanded by $0.25 per gallon in either direction. If another halt were triggered, the market would continue to be expanded by $0.25 per gallon in either direction after each successive five-minute trading halt. There will be no maximum price fluctuation limits during any one trading session.

Options: No price limits.

Last Trading Day
Futures: Trading terminates at the close of business on the last business day of the month preceding the delivery month.

Options: Trading ends three business days before the underlying futures contract.

Exercise of Options
By a clearing member to the Exchange clearinghouse not later than 5:30 P.M., or 45 minutes after the underlying futures settlement price is posted, whichever is later, on any day up to and including the option's expiration.

Options Strike Prices
Twenty strike prices in one-cent-per-gallon increments above and below the at-the-money strike price, and the next ten strike prices in five-cent increments above the highest and below the lowest existing strike prices for a total of at 61 strike prices. The at-the-money strike price is the nearest to the previous day's close of the underlying futures contract. Strike price boundaries are adjusted according to the futures price movements.

Delivery
F.O.B. seller's facility in New York Harbor, ex-shore. All duties, entitlements, taxes, fees, and other charges paid. Requirements for seller's shore facility: capability to deliver into barges. Buyer may request delivery by truck, if available at the seller's facility, and pays a surcharge for truck delivery. Delivery may also be completed by pipeline, tanker, book transfer, or inter- or intra-facility transfer. Delivery must be made in accordance with applicable federal, state, and local licensing and tax laws.

Delivery Period
Deliveries may only be initiated the day after the fifth business day and must be completed before the last business day of the delivery month.

Alternate Delivery Procedure (ADP)
An alternate delivery procedure is available to buyers and sellers who have been matched by the Exchange subsequent to the termination of trading in the spot month contract. If buyer and seller agree to consummate delivery under terms different from those prescribed in the contract specifications, they may proceed on that basis after submitting a notice of their intention to the Exchange.

Exchange of Futures for, or in Connection with, Physicals (EFP)
The commercial buyer or seller may exchange a futures position for a physical position of equal quantity by submitting a notice to the Exchange. EFPs may be used to either initiate or liquidate a futures position.

Grade and Quality Specifications
Generally conforms to industry standards for fungible No. 2 heating oil.

Inspection
The buyer may request an inspection for grade and quality or quantity for all deliveries, but shall require a quantity inspection for a barge, tanker, or inter-facility transfer. If the buyer does not request a quantity inspection, the seller may request such inspection. The cost of the quantity inspection is shared equally by the buyer and seller. If the product meets grade and quality specifications, the cost of the quality inspection is shared jointly by the buyer and seller. If the product fails inspection, the cost is borne by the seller.

Position Accountability Limits
7,000 contracts for all months combined, but not to exceed 1,000 in the last three days of trading in the spot month or 5,000 in any one month.

Margin Requirements
Margins are required for open futures or short options positions. The margin requirement for an options purchaser will never exceed the premium.

Trading Symbols
Futures: HO
Options: OH