Beyond Negative Prices: The Saga of the Commodity and Equity Market
17 Pages Posted: 21 Mar 2021
Date Written: March 12, 2021
The stock market is a dynamic and vibrant arena for both casual and professional investors. Oil has been a particular point of interest in recent news. In March 2020, during the COVID-19 pandemic, and after a series of disagreements within the OPEC+ alliance, an oil price war between Russia and Saudi Arabia took place, which caused prices to decrease drastically. Moreover, the demand for oil dramatically decreased because of the suspension of transportation and air travel. Prices kept dropping, and cost of storage became increasingly unattractive, to the point where traders were willing to pay to get oil taken off their hands. On 4/20/2020, for the first time in history, the generic first crude commodity contract dropped from $10.01 to $-37.63 recording a negative price, puzzling most investors. This unprecedented event shocked the stock market, and most average investors were perplexed on how to calculate returns on negative prices. Interestingly, there was a clear divergence between the equity and energy prices, where the former kept on rallying while the latter completely collapsed into negative territory. This paper pragmatically analyzes the reasons for this divergence between the two markets, the diversification benefit of investing in both assets simultaneously, and presents a “quantum mechanics” methodology to calculate returns when a price goes negative. We find that investors with oil exposure in their portfolios typically tend to outperform those who do not.
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