If you are bullish on cotton, you can profit from a rise in cotton price by taking up a long position in the cotton futures market. You can do so by buying (going long) one or more cotton futures contracts at a futures exchange.
You decide to go long one near-month NYMEX Cotton Futures contract at the price of USD 0.4600 per pound. Since each NYMEX Cotton Futures contract represents 50000 pounds of cotton, the value of the futures contract is USD 23,000. However, instead of paying the full value of the contract, you will only be required to deposit an initial margin of USD 3,375 to open the long futures position.
Assuming that a week later, the price of cotton rises and correspondingly, the price of cotton futures jumps to USD 0.5060 per pound. Each contract is now worth USD 25,300. So by selling your futures contract now, you can exit your long position in cotton futures with a profit of USD 2,300.
|Long Cotton Futures Strategy: Buy LOW, Sell HIGH|
|BUY 50000 pounds of cotton at USD 0.4600/lb||USD 23,000|
|SELL 50000 pounds of cotton at USD 0.5060/lb||USD 25,300|
|Investment (Initial Margin)||USD 3,375|
|Return on Investment||68.1481%|
In the examples shown above, although cotton prices have moved by only 10%, the ROI generated is 68.1481%. This leverage is made possible by the relatively low margin (approximately 14.6739%) required to control a large amount of cotton 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.
To buy or sell futures, you need a broker that can handle futures trades.
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