Understanding the Long and Short of Trading

By Laura Oatney  ISSUE 204 | APRIL 2003

Futures traders use dozens of strategies and variations on strategies to pursue speculative profits. Here are the three most basic approaches.

Buying (Going Long)

If you expect the price of a particular market to increase over time, you can attempt to profit by buying a futures contract. If you are correct in anticipating the direction and timing of price changes, the futures contract can be sold later at a higher price.

Example. In April you paid $4,000 in initial margin to purchase a July crude oil contract at $27 a barrel. Two weeks later, the July contract price has risen to $28 (current price + $1). You decide to sell and take your profit. Each contract represents 1,000 barrels, so your $1 a barrel profit would translate into $1,000 profit, less transaction costs.

Selling (Going Short)

If you expect the price of a market to decrease, you can sell a futures contract. (Yes, you can sell something before you own it. That is one of the benefits of futures trading.) If the price does decline, you can potentially realize a profit by later purchasing an offsetting futures contract at the lower price. You will no longer have a position, and your profit will be the amount by which the purchase price is below the earlier selling price.

Example. It's August and the stock market has been steadily falling. You're convinced that between now and the end of the year prices will continue to decline. The S&P is currently at 860. You decide to sell an E-mini S&P 500 contract. You deposit initial margin of $2,200 and sell one September E-mini S&P 500 futures contract at 860. Each one-point change in the index results in a $50 per contract profit or loss. A decline of 100 points to 760, by the time the contract expires, will yield a profit, before transaction costs, of $5,000.

Spread Trading

Put very simply, spread trading involves the simultaneous purchase of one futures contract and the sale of another futures contract. The objective is to profit from the anticipated change in the relationship between the two prices. There are many, many spread strategies. Some can be very complex, but here are a few of the most basic:

Bear spread - Sell (bearish) the nearby contract month and buy the deferred contract month. (e.g., Sell a May coffee contract and buy a July coffee contract on the New York Board of Trade.)

Bull spread - Buy (bullish) the nearby contract month and sell the deferred contract month. (e.g., Buy a June 30-Day Federal Funds contract and sell a September 30-Day Federal Funds contract at the Chicago Board of Trade.)

Calendar spread - Buy and sell futures contracts on the same commodity, but in different delivery months. (e.g., Buy a July 03 natural gas contract and sell a January 04 natural gas contract at the New York Mercantile Exchange.)

Intermarket spread - Buy and sell the same delivery month of the same commodity on different futures exchanges. (e.g., Buy a July wheat contract at the Chicago Board of Trade and sell a July wheat contract on Kansas City Board of Trade.)

Intercommodity spread - Buy a given delivery month of one commodity and sell the same delivery month of a different, but related, commodity. (e.g., Buy a July soybean contract and sell a July soybean oil contract, both at the Chicago Board of Trade.)   For more information about specific types of spread trades visit Lind-Waldock's Glossary under keyword "spread."

Laura Oatney is editor of LindForum. She can be reached at editor@Lind-Waldock.com.

© 2003 Lind-Waldock, A Division of Man Financial Inc. All Rights Reserved. Futures Trading Involves Risk of Loss.