PrintFunctions of Energy Contracts
Price Discovery
One of the primary functions of energy contracts on the New York Mercantile Exchange is that they provide us price discovery. We can establish a price for crude oil, natural gas, heating oil, and unleaded gasoline for any future point in time. Years back, prior to the advent of the New York Mercantile Exchange, no one could really tell what the price was at any point in time. Most trades were conducted over the telephone. But now, with the New York Mercantile Exchange, at any point in time, you can look up the live trading.
The New York Mercantile Exchange is owned by the Chicago Mercantile Exchange, or the CME Group. If you go to cmegroup.com, you can see the commodity prices. There are some links to that on the home page of the course module here – check to make sure that is true.
Hedging
In addition, this allows us to perform what we call hedging. Hedging is to reduce risk in a transaction. In the case of the futures contracts, it helps us to reduce our price and/or physical risk. We may be concerned about high prices if we're a consumer of energy commodities. We may be concerned about low prices if we are a producer of energy commodities. We may also be concerned about receiving physical supply or having to guarantee physical market. The New York Mercantile Exchange contracts guarantee that.
Terminology
Following are some of the common terms used by NYMEX.
An ask is a motion to sell at a specific price. It's the same as an offer. So ask and offer are interchangeable. It's your asking price. What do you wish to get in the marketplace for your commodity? And notice this is a motion, because they're addressing the idea of the physical trading that takes place in the pits, the movement of hand gestures back and forth as traders buy and sell.
A bid is the opposite of an ask. It's a motion to buy at a specific price. What is your bid for the energy commodity?
A bull is a person who anticipates prices will increase or volatility in the market will increase. They're the opposite of a bear.
A bear is someone who anticipates a decline in price or the volatility in the marketplace. They are the opposite of a bull.