If you are bearish on kerosene, you can profit from a fall in kerosene price by taking up a short position in the kerosene futures market. You can do so by selling (shorting) one or more kerosene futures contracts at a futures exchange.
You decide to go short one near-month TOCOM Kerosene Futures contract at the price of JPY 45,710/kl. Since each Kerosene futures contract represents 50 kiloliters of kerosene, the value of the contract is JPY 2,285,500. To enter the short futures position, you have to put up an initial margin of JPY 210,000.
A week later, the price of kerosene falls and correspondingly, the price of TOCOM Kerosene futures drops to JPY 41,139 per kiloliter. Each contract is now worth only JPY 2,056,950. So by closing out your futures position now, you can exit your short position in Kerosene Futures with a profit of JPY 228,550.
|Short Kerosene Futures Strategy: Sell HIGH, Buy LOW|
|SELL 50 kiloliters of kerosene at JPY 45,710/kl||JPY 2,285,500|
|BUY 50 kiloliters of kerosene at JPY 41,139/kl||JPY 2,056,950|
|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 0%. 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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