By guest contributor Harry Cator, Executive Chairman, DMP Asset Management
The recent debacle in the oil futures market is yet another example of structured products being exposed, badly, when markets dislocate.
My greatest friend, a market maker of yesteryear in the City of London, reminded me of the obligation of market makers to make a market when asked for a price and how, in the commodity space at the expiry of a futures contract, you had to take or deliver the physical commodity.
Around Easter and Christmas each year the phone would ring with a wily punter asking my friend for a price in 10,000 Cadbury’s Cream Eggs! At Christmas, it was the price for 100 3-feet tall Christmas Trees…..we both remember 100 3-feet Christmas trees being ferried around the heart of the finance district in London Black Cabs as said trees were duly delivered to the unfortunate market maker who ended up with the contract. The 10,000 Cadbury Cream Eggs were an easier item to move around the market! It was fun back then….
The “side of potatoes” was a more serious issue. A Lincolnshire potato farmer drove his potato crop (many tons loaded onto many tractors and trailers) down the M1 motorway, dumped them in the doorway to the Baltic Exchange, the home to the commodities futures trading floor, thereby blocking everyone in the Exchange. Some end-holder of his potato futures contract refused to take physical delivery of the underlying volume of potatoes until the delivery was forced upon him!
Wind forward the clock 30 years, and whilst history does not repeat, it does rhyme and on each rhyming occasion the cost goes up. How can the manager of the US oil ETF in question have missed that if you hold a commodity futures contract at the expiry of said contract then you are obliged to take physical delivery? The really sad thing is that for those companies operating in the real world of oil such Micky Mouse behaviour on the part of supposed professionals can cause serious financial distress. Just ask the potato farmer.