If you are bullish on kerosene, you can profit from a rise in kerosene price by taking up a long position in the kerosene futures market. You can do so by buying (going long) one or more kerosene futures contracts at a futures exchange.
You decide to go long one near-month TOCOM Kerosene Futures contract at the price of JPY 45,710 per kiloliter. Since each TOCOM Kerosene Futures contract represents 50 kiloliters of kerosene, the value of the futures contract is JPY 2,285,500. However, instead of paying the full value of the contract, you will only be required to deposit an initial margin of JPY 210,000 to open the long futures position.
Assuming that a week later, the price of kerosene rises and correspondingly, the price of kerosene futures jumps to JPY 50,281 per kiloliter. Each contract is now worth JPY 2,514,050. So by selling your futures contract now, you can exit your long position in kerosene futures with a profit of JPY 228,550.
|Long Kerosene Futures Strategy: Buy LOW, Sell HIGH|
|BUY 50 kiloliters of kerosene at JPY 45,710/kl||JPY 2,285,500|
|SELL 50 kiloliters of kerosene at JPY 50,281/kl||JPY 2,514,050|
|Investment (Initial Margin)||JPY 210,000|
|Return on Investment||109%|
In the examples shown above, although kerosene prices have moved by only 10%, the ROI generated is 109%. This leverage is made possible by the relatively low margin (approximately 9%) required to control a large amount of kerosene 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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