If you are bearish on pork bellies, you can profit from a fall in pork bellies price by taking up a short position in the pork bellies futures market. You can do so by selling (shorting) one or more pork bellies futures contracts at a futures exchange.
You decide to go short one near-month CME Frozen Pork Bellies Futures contract at the price of USD 0.8470/lb. Since each Frozen Pork Bellies futures contract represents 40000 pounds of pork bellies, the value of the contract is USD 33,880. To enter the short futures position, you have to put up an initial margin of USD 1,890.
A week later, the price of pork bellies falls and correspondingly, the price of CME Frozen Pork Bellies futures drops to USD 0.7623 per pound. Each contract is now worth only USD 30,492. So by closing out your futures position now, you can exit your short position in Frozen Pork Bellies Futures with a profit of USD 3,388.
|Short Pork Bellies Futures Strategy: Sell HIGH, Buy LOW|
|SELL 40000 pounds of pork bellies at USD 0.8470/lb||USD 33,880|
|BUY 40000 pounds of pork bellies at USD 0.7623/lb||USD 30,492|
|Investment (Initial Margin)||USD 1,890|
|Return on Investment||179.2593%|
In the examples shown above, although pork bellies prices have moved by only 10%, the ROI generated is 0.0000%. This leverage is made possible by the relatively low margin (approximately 5.5785%) required to control a large amount of pork bellies 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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