Copyright © 2008, The McGraw-Hill Companies, Inc.
In theory, Jimmy has two contracts running, but no actual financial stake in the oil, since
the two contracts cancel each other out. Rather than keep those two contracts running, the
exchange will normally instead match the short and long contracts, require Jimmy to pay
the difference between them, and remove him from the picture entirely. In this case we say
that Jimmy has closed his position.Margins and Returns as a Percent
Determining the percentage return on a commodities investment can be tricky. It was
not hard to see that Luis made $3,475, but if we want to look at it as a percent, what
is it a percent of? Luis really did not have to invest any actual money—it appears that
he made a profit without putting any money on the table. In reality, though, the futures
exchange requires each party to a contract to put up a certain amount of money to be held
in reserve while the contract is in place. This is called posting a margin for the contract.
This prevents someone from making promises he can’t keep. Both parties to a futures
contract need to know that the other party has the means to settle the contract. The margin
provides that assurance.
The margin that must be posted for a given contract can vary, depending on the com-
modity in question and the rules of the exchange on which the contract is being traded. It
is common for the initial margin, the margin that must be posted up front, to be 5% of the
eventual value of the contract. If prices start to move against you, you can be required to
post additional margin (called a margin call) or close your position.Example 6.3.4 Suppose that Luis (from Example 6.3.2) was required to post a 5%
initial margin, and there were no margin calls along the way. Also, suppose that the
time between when he opened his position and the contract’s expiration was 47 days.
Find (a) his percent profi t and (b) his profi t as a rate of return.The margin Luis had to post was (5%)($30,625) $1,531.25.(a) Luis made a $3,475 profi t on a $1,531.25 investment. This amounts to a $3,475/$1,531.25
2.2694 226.94% profi t. While it does express the profi t as a percent of the amount
invested, this fi gure does not take into account the time involved.(b) If we look at this as his principal and calculate a simple interest rate using it, we fi nd that
his percent rate of return is:I = PRT
$3,475 = $1,531.25(R)(47/365)
R 17.6240 1,762.40%(We chose to calculate this as simple rather than compound interest because the length
of time is short and the simple interest formula is easier to work with in this case. See the
Additional Exercises for an example of this calculation using a compound rate.)This percent rate of return is astounding, far higher than anything we might have imagined
from stocks, bonds, and similar lower-adrenaline investments. This sort of return is made
possible by the fact that the amount that Luis had to actually invest is quite small in relation
to the overall value of the soybeans involved. Thus, even a fairly small percent movement
in the value of the soybeans translates into a large percent measured against Luis’s margin.
This effect is referred to as leverage.
Before we get too excited about the potential leverage offers to earn such eye-popping
percent returns, it is important to realize that just as the margin is small in comparison to
the potential gain, it also quite small in comparison to the potential loss.Example 6.3.5 Suppose that Jimmy (from Example 6.3.3) was required to post an
initial margin of 5%, and that the time between his initial long position and his closing
short position was 52 days. Calculated Jimmy’s return as (a) a percent and (b) as a
simple rate of return.Jimmy’s initial margin would have been (5%)($75,090) $3754.50.6.3 Commodities, Options, and Futures Contracts 279