If you are bearish on ethanol, you can profit from a fall in ethanol price by taking up a short position in the ethanol futures market. You can do so by selling (shorting) one or more ethanol futures contracts at a futures exchange.
You decide to go short one near-month CBOT Ethanol Futures contract at the price of USD 1.5800/gal. Since each Ethanol futures contract represents 29000 gallons of ethanol, the value of the contract is USD 45,820. To enter the short futures position, you have to put up an initial margin of USD 6,480.
A week later, the price of ethanol falls and correspondingly, the price of CBOT Ethanol futures drops to USD 1.4220 per gallon. Each contract is now worth only USD 41,238. So by closing out your futures position now, you can exit your short position in Ethanol Futures with a profit of USD 4,582.
|Short Ethanol Futures Strategy: Sell HIGH, Buy LOW|
|SELL 29000 gallons of ethanol at USD 1.5800/gal||USD 45,820|
|BUY 29000 gallons of ethanol at USD 1.4220/gal||USD 41,238|
|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 0.0000%. 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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