If you are bearish on lean hogs, you can profit from a fall in lean hogs price by taking up a short position in the lean hogs futures market. You can do so by selling (shorting) one or more lean hogs futures contracts at a futures exchange.
You decide to go short one near-month CME Lean Hogs Futures contract at the price of USD 0.6015/lb. Since each Lean Hogs futures contract represents 40000 pounds of lean hogs, the value of the contract is USD 24,060. To enter the short futures position, you have to put up an initial margin of USD 1,350.
A week later, the price of lean hogs falls and correspondingly, the price of CME Lean Hogs futures drops to USD 0.5414 per pound. Each contract is now worth only USD 21,654. So by closing out your futures position now, you can exit your short position in Lean Hogs Futures with a profit of USD 2,406.
|Short Lean Hogs Futures Strategy: Sell HIGH, Buy LOW|
|SELL 40000 pounds of lean hogs at USD 0.6015/lb||USD 24,060|
|BUY 40000 pounds of lean hogs at USD 0.5414/lb||USD 21,654|
|Investment (Initial Margin)||USD 1,350|
|Return on Investment||178.2222%|
In the examples shown above, although lean hogs prices have moved by only 10%, the ROI generated is 0.0000%. This leverage is made possible by the relatively low margin (approximately 5.6110%) required to control a large amount of lean hogs 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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