IG’s Oil Pricing Explained

In light of recent events, this article explains the particulars behind IG’s pricing in regards to oil, and how they too could potentially go into negative.

With oil prices on some data providers crashing into the negative, you’ve probably noticed that oil prices on IG’s trading platform haven’t (thus far), and that has to do with how prices are extracted. To put things into context, it was the infamous May contract (which has now expired) that went into negative territory, but given how oil prices are extracted, spot oil prices on IG’s trading platform didn’t go anywhere below $0 (or even below $20 at the time) when the rollover mayhem occurred in the oil futures market.

So how exactly does IG price its spot oil?

Two futures contracts are used to price our spot price, and that’s a combination of the nearest (or front month) contract to the next, further (back month) contract, essentially moving towards the further contract as time progresses.

The May contract went negative at the very end prior to settlement, and at the start IG’s spot oil price is much closer to the June price than the July price, explaining the similarity between the platform’s price and the June contract compared to the higher priced July contract. Expect the platform’s price to reflect less of the June contract and more of the July contract as time progresses.

That makes oil prices on the platform different from that seen on other platforms, and has resulted in oil prices on IG’s platform avoiding Monday’s carnage that may have been witnessed on other platforms. In fact, if other data or trading platforms incorporate the cost-of-carry, then you might have seen prices below that of the front month contract.

Can IG’s oil prices go negative?

Absolutely, but here we need to look at the different contracts on the platform.

If it’s our futures contracts (June and July are presently available), then should the underlying contract go into negative, then that would translate into negative prices on our platform for that specific product that tracks the underlying that went negative. In other words, if June goes negative, you would see that on the platform, same holds true for July, and if both went negative you would see negative prices on both futures contracts on the trading platform.

As for spot (or undated contracts), as explained previously its based on the front and back month, and that means negative oil prices can’t be ruled out, as should the current June and/or July oil contracts go negative, and that would translate into negative prices on our platform as well, especially if the June contract plummets more when the price bias from the contract is higher earlier on, and will be less of a factor as time progresses and the spot contract’s price takes a heavier weight from the back month July contract.

Trading when the product goes negative and calculating margins

If you have an open position and oil prices do go negative on the June contract for example, you can still close that position (at the very least, close-only will be available should prices go negative). In terms of calculating margins, it is calculated as the higher of (1) 5%, or (2) 80 points times the positions.

For example, if you have one contract on US Crude Oil, then the result at a price of 1394.4 would be calculated as such (1) 10 x 1394.4 x 5% = $697.20, and (2) 80 x $10 = $800. The higher value in this example is $800, which would be the margin in this example, as well as for any price below and into negative territory. Should oil prices recover to a price of $1601 and above, then margins would be calculated using the first method.

Overnight funding

Given the difference in pricing the undated contracts for commodities, the overnight funding model will also differ. Here it’s based on two parts:

Admin Charge: This is a charge to the client and is 2.5% of the notional value of the trade annually, and hence is calculated by taking the price (for example) 1 x $10 (1394.4 x 2.5% / 365) = $0.93.

Basis Adjustment: This is an adjustment and not a charge, and can be positive or negative depending on the difference between the front and back month contracts. The basis equates the daily movement of our undated price along the futures curve, and depends on the difference between the two. Because the undated contract is in constant motion moving closer to the next month and away from the front month, the pricing model makes the adjustment accordingly. The adjustment is made by the following formula:

(Price of the next future – price of the front future) / (Expiry of the front future – expiry of the previous front future)

Contango is the normal state of the futures market, where the next contract is pricier than the current contract and so on. However, in the current coronavirus storm we’ve been seeing an extreme case of contango where current prices on a lack of demand (and dwindling storage capabilities) have been plummeting but where prices in the next contract are much higher anticipating output cuts and an ease in lockdown restrictions. That has meant that the Basis Adjustment has been higher as the ‘Price of the next future – price of the front future’ has grown to massive proportions.

Should backwardation occur where the next futures contract price is lower than the front month, and that would translate into clients receiving a basis adjustment as time progresses instead of the current scenario where the basis adjustment has been significantly higher.

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