Suppose You Enter Into A Long Futures Contract To Buy M

Suppose That You Enter Into A Long Futures Contract To Buy May Gasolin

Suppose that you enter into a long futures contract to buy May gasoline at $0.80 per gallon on the New York Commodity Exchange. The contract size is 42,000 gallons. The initial margin requirement is $2,000, and the maintenance margin is $1,500.

Since you are holding a long position, a decline in the futures price could lead to a margin call, as it would result in a loss on your position. The question is: what change in the futures price would trigger a margin call?

To determine this, we need to analyze how much the price can decline before your margin account falls below the maintenance margin, prompting a margin call. First, calculate the maximum allowable loss in your margin account before reaching the maintenance margin threshold:

Maximum loss tolerated = Initial margin - Maintenance margin = $2,000 - $1,500 = $500.

This $500 loss represents the decline in total position value before a margin call occurs.

The total position size is 42,000 gallons. The per-gallon decrease in futures price that would lead to a $500 loss is:

Loss per gallon = Total loss / Contract size = $500 / 42,000 gallons ≈ $0.0119.

Given that you entered into the contract at $0.80 per gallon, a price decline exceeding this per-gallon amount would cause your account balance to fall below the maintenance margin, triggering a margin call.

Therefore, the futures price level at which a margin call occurs is:

Price for margin call = Entry price - decline = $0.80 - $0.0119 ≈ $0.788 per gallon.

In conclusion, if the futures price of gasoline declines below approximately $0.788 per gallon, your account will be impinged upon the maintenance margin threshold, and a margin call will be issued requiring you to deposit additional funds to maintain your position.

Paper For Above instruction

The dynamics of futures trading involve significant risk and require careful management of margin requirements, especially for commodities such as gasoline that are susceptible to price volatility. When entering a long futures contract, traders anticipate an increase in the underlying asset's price, but adverse price movements can lead to financial distress if margin thresholds are breached. This essay explores how changes in gasoline futures prices impact margin calls, illustrating the case with a specific example involving a contract on the New York Commodity Exchange.

Futures contracts are standardized agreements to buy or sell an asset at a predetermined price at a specified future date. In the gasoline futures market, each contract often covers large quantities—in this case, 42,000 gallons. Traders are required to maintain an initial margin—depositing a set amount of capital to open a position—and an ongoing maintenance margin that ensures the trader maintains a sufficient equity cushion. If the position moves against the trader, and the account equity falls below the maintenance margin, a margin call is issued, requiring additional funds to restore the margin level.

In the scenario outlined, an investor enters a long position at $0.80 per gallon with an initial margin of $2,000. The subsequent decline in gasoline prices diminishes the value of the position, resulting in a potential margin call once losses reach a critical point. To determine this point, one calculates the maximum allowable loss before the account falls below the maintenance margin threshold. The difference between the initial margin and the maintenance margin (i.e., $500) constrains how far the price can decline without triggering a margin call.

Given the size of the contract—42,000 gallons—the per-gallon loss tolerance is $500 divided by 42,000, approximately $0.0119. This means that a decline of more than roughly $0.0119 per gallon from the purchase price of $0.80 per gallon would cause the trader's margin balance to dip below $1,500, leading to a margin call. Consequently, the critical price level for a margin call is approximately $0.788 per gallon ($0.80 minus $0.0119).

Understanding this threshold is vital for traders, as gasoline prices are highly volatile, influenced by geopolitical events, seasonal demands, and macroeconomic factors. The potential for a margin call necessitates risk management strategies, such as setting stop-loss orders or maintaining additional margin reserves, to prevent forced liquidation due to adverse price movements.

In practical terms, traders must continuously monitor market movements and margins, especially during periods of heightened volatility. The example underscores the importance of knowing the margins and how price fluctuations can impact trading positions. If gasoline prices plummet below the identified point, the trader must swiftly deposit additional funds to avoid liquidation, which could result in significant financial losses.

This case also highlights broader themes in commodity trading: the need for disciplined risk management, the critical role of margin requirements in financial markets, and the importance of understanding the leverage associated with futures contracts. While futures are useful for hedging and speculation, they carry risks that can be magnified by small price movements, emphasizing the importance of education and prudent trading practices.

In conclusion, the level at which a margin call is triggered in gasoline futures depends directly on the initial contract size, the margin requirements, and the price decline. This example vividly illustrates the mechanics behind margin calls and the importance of strategic risk management in futures trading, especially for volatile commodities like gasoline.

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