If you are bearish on rice, you can profit from a fall in rice price by taking up a short position in the rice futures market. You can do so by selling (shorting) one or more rice futures contracts at a futures exchange.
You decide to go short one near-month CBOT Rough Rice Futures contract at the price of USD 13.71/cwt. Since each Rough Rice futures contract represents 2000 hundredweights of rice, the value of the contract is USD 27,420. To enter the short futures position, you have to put up an initial margin of USD 2,430.
A week later, the price of rice falls and correspondingly, the price of CBOT Rough Rice futures drops to USD 12.34 per hundredweight. Each contract is now worth only USD 24,678. So by closing out your futures position now, you can exit your short position in Rough Rice Futures with a profit of USD 2,742.
|Short Rice Futures Strategy: Sell HIGH, Buy LOW|
|SELL 2000 hundredweights of rice at USD 13.71/cwt||USD 27,420|
|BUY 2000 hundredweights of rice at USD 12.34/cwt||USD 24,678|
|Investment (Initial Margin)||USD 2,430|
|Return on Investment||112.84%|
In the examples shown above, although rice prices have moved by only 10%, the ROI generated is 0.00%. This leverage is made possible by the relatively low margin (approximately 8.86%) required to control a large amount of rice 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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