If you are bearish on heating oil, you can profit from a fall in heating oil price by taking up a short position in the heating oil futures market. You can do so by selling (shorting) one or more heating oil futures contracts at a futures exchange.
You decide to go short one near-month NYMEX Heating Oil Futures contract at the price of USD 1.4777/gal. Since each Heating Oil futures contract represents 42000 gallons of heating oil, the value of the contract is USD 62,063. To enter the short futures position, you have to put up an initial margin of USD 10,125.
A week later, the price of heating oil falls and correspondingly, the price of NYMEX Heating Oil futures drops to USD 1.3299 per gallon. Each contract is now worth only USD 55,857. So by closing out your futures position now, you can exit your short position in Heating Oil Futures with a profit of USD 6,206.
|Short Heating Oil Futures Strategy: Sell HIGH, Buy LOW|
|SELL 42000 gallons of heating oil at USD 1.4777/gal||USD 62,063|
|BUY 42000 gallons of heating oil at USD 1.3299/gal||USD 55,857|
|Investment (Initial Margin)||USD 10,125|
|Return on Investment||61.2972%|
In the examples shown above, although heating oil prices have moved by only 10%, the ROI generated is 0.0000%. This leverage is made possible by the relatively low margin (approximately 16.3140%) required to control a large amount of heating oil 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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