Interview question

Guys I recently had an interview with an investment banking firm. They asked me a number of questions relating to economics and derivatives.

One stood out in particular for me. They asked me if I wanted to move large amounts of oil from the Middle East to Europe how would I do it? They also specified that I should use derivative contracts and that the outlook for the price of oil is positive.

So I just said purchase a basic long futures contract on oil. They didn’t specify how many barrels they wanted.

I thought it strange that they made me use derivatives. Would any of you have done it a different way? Also I pondered the question as to what if the outlook was negative?

The first part is easy. You would sell crude oil forwards/futures for delivery in the Middle East on some date, and buy oil forwards/futures for delivery in Europe on the same date. So, on the settlement date, you will deliver your crude oil in the Middle East, and some party will deliver oil to you in Europe. Assume here that the oil units are interchangeable (i.e. no quality difference and so on), and that such contracts exist and are liquid.

The second part, regarding outlook, requires more clarification: particularly on whether this price outlook is reflected in the futures curve. If the outlook is positive and the outlook is not reflected in the futures curve, you would want to hold a net long position for some amount of time. So, instead of trading the two contracts above at the same time, you could buy the Europe contract first, wait some time, and then sell the Middle East contract later, when you think the price will be higher.

If the positive price outlook has already been reflected in the forward curve, then this might be less feasible, since the future price on your intended settlement date might not change with spot price. In this case, you could consider buying physical oil in Europe, storing it, and selling the same Middle East contract as above. The economics are dependent on storage costs here.

If the outlook is negative and not reflected in the futures curve, reverse the timing from two paragraphs above. If the outlook is negative and reflected in the futures curve, then consider selling your crude oil physically, and buying the European contract for future delivery at a lower price.

Good answer Ohai. Throw in backwardation and contango as buzz words and you got yourself a job in I-banking.

what ohai said but also in the mean time invest in 3x long OIL ETFs with as much leverage as possible

Only if you are REALLY REALLY REALLY sure about your positive outlook and you can cover your leveraged positions.

See: Amaranth - Brian Hunter

Haha I think he was kidding kurtosis

Igor may have been joking, but the OP might take him seriously since he’s pretty green.

yea i was joking, dont say that OP

Even if you “REALLY REALLY REALLY” were sure (which there’s no way you could be unless you were naive or had insider info), it would be irresponsible to take that position. The only situation I could see that trade being “reasonably” taken would be if you were a trader with a death wish.

You could be REALLY REALLY REALLY sure if you are the King of Saudi Arabia.

I don’t understand Igor’s joke? It’s risky but how does that apply to OP’s question?