If you are bearish on coffee, you can profit from a fall in coffee price by taking up a short position in the coffee futures market. You can do so by selling (shorting) one or more coffee futures contracts at a futures exchange.
You decide to go short one near-month Euronext Robusta Coffee (No. 409) Futures contract at the price of USD 1,648/ton. Since each Robusta Coffee (No. 409) futures contract represents 10 tonnes of coffee, the value of the contract is USD 16,480. To enter the short futures position, you have to put up an initial margin of USD 1,600.
A week later, the price of coffee falls and correspondingly, the price of Euronext Robusta Coffee (No. 409) futures drops to USD 1,483 per tonne. Each contract is now worth only USD 14,832. So by closing out your futures position now, you can exit your short position in Robusta Coffee (No. 409) Futures with a profit of USD 1,648.
|Short Coffee Futures Strategy: Sell HIGH, Buy LOW|
|SELL 10 tonnes of coffee at USD 1,648/ton||USD 16,480|
|BUY 10 tonnes of coffee at USD 1,483/ton||USD 14,832|
|Investment (Initial Margin)||USD 1,600|
|Return on Investment||103%|
In the examples shown above, although coffee prices have moved by only 10%, the ROI generated is 0%. This leverage is made possible by the relatively low margin (approximately 10%) required to control a large amount of coffee 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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