can you translate trader-speak?

Question

"physical" trades and "non physical" trades in the same commodity... what does this mean?

Answer 1

Some trades have what is called "physical settlement" - ie, you take actual delivery of what is being traded.

For instance, an airline might buy a Fuel Forward - x number of gallons of aviation fuel for delivery 3 months from now at a certain price - and on that day they want the actual oil.

Financial or non-physical settlement is when you get money instead. So you might want to do a trade in, say, Gold 3 months from now: 100 ounces at $500 an ounce. When that day comes, the market price for gold is $510 dollars an ounce. The trader will pay you $10 x 100 = $1000 dollars, and you can go out and buy the gold yourself, and it will cost you a net $50,000.

The reason for splitting the function is that then people - or especially banks - can trade in commodities without having to have the physical capacity to handle them. That makes markets more "liquid" (it's easier to find someone to take your trade) and so brings down margins.

Also, it means that if you have a specialised requirement (say fuel of a particular octane rating), then you can hedge against the price of that using a more widely (and therefore more easily) traded standard commodity such as Brent Crude, so long as that is highly correlated to the price of the thing you actually DO want. You can cover your financial risk cheaply, but still buy exactly what you need.

Answer 2

The answer given above already is very good.
Might add that there are 2 colloquial terms used in oil trading that you may want to know as well; 'wet' and 'paper' deals, wet meaning physical and the other a financial, or non-physical. one.