The futures price of gold is $1,250. Future contracts are for 100 ounces of gold

Question

The futures price of gold is $1,250. Future contracts are for 100 ounces of gold, and the margin requirement is $5,000 a contract. The maintenance margin requirement is $2,500. You expect the price of gold to go down; therefore you short one gold future contract at the prevailing price of $1,250. Show your work.

a. How much must you initially remit in order to be able to short gold future?

b. If future price of gold rises to $1,265, do you make a profit or loss?

c. Estimate your profit or loss both in dollar and in percent if future gold price goes up to 1,265.

d. If the future price of gold declines to $1,230, estimate your profit or loss? Assume you shorted at $1,250

Explanation / Answer

a.       How much must you initially remit in order to be able to short gold future?

Initially you have to transfer initial margin amount of $ 5,000 against short position of 100 ounces of gold @ $ 1,250 (exercise price). To take short position you have to transfer initial margin of $ 5,000

b.       If future price of gold rises to $1,265, do you make a profit or loss?

We will make loss because we are short in the position of gold. We will make profit only if the future prices keep falling below $ 1,250.

The loss would be = (Exercise price - Price) x 100 ounces of gold = (1250 -1265) x 100 = - 1500 charged to margin account. This implies Profit or loss of - $ 1500 or ( “ - “sign represents loss). $ 1500 is loss.

c.       Estimate your profit or loss both in dollar and in percent if future gold price goes up to 1,265.

(Exercise price - Price) x 100 ounces of gold = (1250 -1265) x 100 = - $ 1500

Therefore, Dollar loss = $ 1500

Loss of $ 1,500 on invested amount $5,000 as initial margin. The percentage loss will be 1500 / 5000 = 30% loss or loss percentage is 30 (30% Loss)

or

Percentage loss: Loss is 30% of initial margin.

d. If the future price of gold declines to $1,230, estimate your profit or loss? Assume you shorted at $1,250

We can again apply formula of:

(Exercise price - Price) x 100 ounces of gold = (1250 -1230) x 100 = $ 2,000 is profit

Profit of $ 2,000 will be credited to margin account.

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