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Basic Futures Trading Strategies
Even if you should decide to participate in futures trading
in a way that doesn't involve having to make day-to-day
trading decisions (such as a managed account or commodity
pool), it is nonetheless useful to understand the dollars
and cents of how futures trading gains and losses are
realized. And, of course, if you intend to trade your own
account, such an understanding is essential.
Dozens of different strategies and variations of strategies are employed by futures traders in pursuit of speculative profits. Here is a brief description and illustration of several basic strategies.
For example, assume it's now January, the July soybean futures contract is presently quoted at $6.00, and over the coming months you expect the price to increase. You decide to deposit the required initial margin of, say, $1,500 and buy one July soybean futures contract. Further assume that by April the July soybean futures price has risen to $6.40 and you decide to take your profit by selling. Since each contract is for 5,000 bushels, your 40-cent a bushel profit would be 5,000 bushels x 40 cents or $2,000 less transaction costs.
* For simplicity examples do not take into account commissions and other transaction costs. These costs are important, however, and you should be sure you fully understand them. Suppose, however, that rather than rising to $6.40, the July soybean futures price had declined to $5.60 and that, in order to avoid the possibility of further loss, you elect to sell the contract at that price. On 5,000 bushels your 40-cent a bushel loss would thus come to $2,000 plus transaction costs.
Note that the loss in this example exceeded your $1,500 initial margin. Your broker would then call upon you, as needed, for additional margin funds to cover the loss. Selling (Going Short) to Profit from an Expected Price Decrease
The only way going short to profit from an expected
price decrease differs from going long to profit
from an expected price increase is the sequence of
the trades. Instead of first buying a futures
contract, you first sell a futures contract. If, as
expected, the price declines, a profit can be
realized by later purchasing an offsetting futures
contract at the lower price. The gain per unit will
be the amount by which the purchase price is below
the earlier selling price. For example, assume that
in January your research or other available
information indicates a probable decrease in cattle
prices over the next several months. In the hope of
profiting, you deposit an initial margin of $2,000
and sell one April live cattle futures contract at a
price of, say, 65 cents a pound. Each contract is
for 40,000 pounds, meaning each 1 cent a pound
change in price will increase or decrease the value
of the futures contract by $400. If, by March, the
price has declined to 60 cents a pound, an
offsetting futures contract can be purchased at 5
cents a pound below the original selling price. On
the 40,000 pound contract, that's a gain of 5 cents
x 40,000 lbs. or $2,000 less transaction costs.
Assume you were wrong. Instead of decreasing, the April live cattle futures price increases--to, say, 70 cents a pound by the time in March when you eventually liquidate your short futures position through an offsetting purchase. The outcome would be as follows:
In this example, the loss of 5 cents a pound on the futures transaction resulted in a total loss of the $2,000 you deposited as initial margin plus transaction costs. |
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