If you are bearish on aluminum, you can profit from a fall in aluminum price by taking up a short position in the aluminum futures market. You can do so by selling (shorting) one or more aluminum futures contracts at a futures exchange.
You decide to go short one near-month LME Aluminum Futures contract at the price of USD 1,470/ton. Since each Aluminum futures contract represents 25 tonnes of aluminum, the value of the contract is USD 36,750. To enter the short futures position, you have to put up an initial margin of USD 4,375.
A week later, the price of aluminum falls and correspondingly, the price of LME Aluminum futures drops to USD 1,323 per tonne. Each contract is now worth only USD 33,075. So by closing out your futures position now, you can exit your short position in Aluminum Futures with a profit of USD 3,675.
|Short Aluminum Futures Strategy: Sell HIGH, Buy LOW|
|SELL 25 tonnes of aluminum at USD 1,470/ton||USD 36,750|
|BUY 25 tonnes of aluminum at USD 1,323/ton||USD 33,075|
|Investment (Initial Margin)||USD 4,375|
|Return on Investment||84%|
In the examples shown above, although aluminum prices have moved by only 10%, the ROI generated is 0%. This leverage is made possible by the relatively low margin (approximately 12%) required to control a large amount of aluminum represented by each contract.
Leverage is a double edged weapon. The above examples only depict positive scenarios whereby the market is favorable towards you. If the market turn against you, you will be required to top up your account to meet the margin requirements in order for your futures position to remain open.
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