If you are bullish on ethanol, you can profit from a rise in ethanol price by taking up a long position in the ethanol futures market. You can do so by buying (going long) one or more ethanol futures contracts at a futures exchange.
You decide to go long one near-month CBOT Ethanol Futures contract at the price of USD 1.5800 per gallon. Since each CBOT Ethanol Futures contract represents 29000 gallons of ethanol, the value of the futures contract is USD 45,820. However, instead of paying the full value of the contract, you will only be required to deposit an initial margin of USD 6,480 to open the long futures position.
Assuming that a week later, the price of ethanol rises and correspondingly, the price of ethanol futures jumps to USD 1.7380 per gallon. Each contract is now worth USD 50,402. So by selling your futures contract now, you can exit your long position in ethanol futures with a profit of USD 4,582.
|Long Ethanol Futures Strategy: Buy LOW, Sell HIGH|
|BUY 29000 gallons of ethanol at USD 1.5800/gal||USD 45,820|
|SELL 29000 gallons of ethanol at USD 1.7380/gal||USD 50,402|
|Investment (Initial Margin)||USD 6,480|
|Return on Investment||70.7099%|
In the examples shown above, although ethanol prices have moved by only 10%, the ROI generated is 70.7099%. This leverage is made possible by the relatively low margin (approximately 14.1423%) required to control a large amount of ethanol 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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