Futures: Strategies for Futures
Essentially, futures contracts try to predict what
the value of an index or commodity will be at some date in the future. There are
two positions that you can take in a futures contract. Dozens of different
strategies and variations of strategies are employed by futures traders in
pursuit of speculative profits. The most common are known as “going long,”
“going short” and “spreads.” Here is a brief description and illustration of
several basic strategies.
Buying (Going Long) - Someone expecting the price of a particular
commodity or item to increase over from a given period of time can seek to
profit by buying futures contracts. If correct in forecasting the direction
and timing of the price change, the futures contract can later be sold for
the higher price, thereby yielding a profit. If the price declines rather
than increases, the trade will result in a loss. Because of leverage, the
gain or loss may be greater than the initial margin deposit.
For example, assume
it's now January, the July corn futures contract is presently quoted at
$2.00, and over the coming months you expect the price to increase. You
decide to deposit the required initial margin of, say, $1,000 and buy one
July corn futures contract. Further assume that by April the July corn
futures price has risen to $2.40 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.
Suppose, however, that rather than
rising to $2.40, the July corn futures price had declined to $1.60 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 $1,000 initial margin. Your broker would then call upon you, as
needed, for additional margin funds to cover the loss (margin call).
Selling (Going short) - You go
short if you think a specific commodity will decrease in price. 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. It sounds weird, but you can
sell before you buy in futures market. 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. in the above example, you
would profit if the price of corn went down instead of up. It's total
opposite of going long, you lose money when the price of corn goes up.
Spreads
As you can see, going long and going short are positions that basically
involve the buying or selling of a contract now in order to take advantage of
rising or declining prices in the future. Another common strategy used by
futures traders is called “spreads.”
Spreads involve taking advantage of the price difference between two different
contracts of the same commodity. Spreading is considered to be one of the most
conservative forms of trading in the futures market because it is much safer
than the trading of long/short (naked) futures contracts.
There are many different types of spreads, including:
-
Calendar spread – This involves the simultaneous purchase and sale of
two futures of the same type, having the same price, but different delivery
dates.
-
Inter-Market spread – Here the investor, with contracts of the same
month, goes long in one market and short in another market. For example, the
investor may take Short June Wheat and Long June Pork Bellies.
-
Inter-Exchange spread – This is any type of spread in which each
position is created in different futures exchanges. For example, the investor
may create a position in the Chicago Board of Trade (CBOT) and the London
International Financial Futures and Options Exchange (LIFFE).
Next ==>> Benefits of
Futures
If
you worried about falling off the bike, you'd never get on.
-- Lance Armstrong --
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