If you are bearish on live cattle, you can profit from a fall in live cattle price by taking up a short position in the live cattle futures market. You can do so by selling (shorting) one or more live cattle futures contracts at a futures exchange.
You decide to go short one near-month CME Live Cattle Futures contract at the price of USD 0.8445/lb. Since each Live Cattle futures contract represents 40000 pounds of live cattle, the value of the contract is USD 33,780. To enter the short futures position, you have to put up an initial margin of USD 1,620.
A week later, the price of live cattle falls and correspondingly, the price of CME Live Cattle futures drops to USD 0.7601 per pound. Each contract is now worth only USD 30,402. So by closing out your futures position now, you can exit your short position in Live Cattle Futures with a profit of USD 3,378.
|Short Live Cattle Futures Strategy: Sell HIGH, Buy LOW|
|SELL 40000 pounds of live cattle at USD 0.8445/lb||USD 33,780|
|BUY 40000 pounds of live cattle at USD 0.7601/lb||USD 30,402|
|Investment (Initial Margin)||USD 1,620|
|Return on Investment||208.5185%|
In the examples shown above, although live cattle prices have moved by only 10%, the ROI generated is 0.0000%. This leverage is made possible by the relatively low margin (approximately 4.7957%) required to control a large amount of live cattle 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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