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actually own the commodity (in this case gold), but let the clearing
house worry about that. This means that you are actually selling
something that you don’t own and probably never will, but if you don’t
settle your contracts prior to maturity, you would then need to make
good on the contracts by purchasing the gold on the spot market and
making the delivery. This leads us into the discussion of margin and the
power of leverage, which we will cover in the next section.
But even if you did own some gold against which you sell futures
contracts, you may not want to necessarily give up your stash. And if
you believe that gold prices are headed lower, what better way to take
advantage of this price drop than to sell gold futures contracts, settle
them later on (by going long), and pocket the difference? You will still
get to keep your gold while making a profit selling gold contracts. But
not so fast. The downside would be if those gold contracts start to climb
beyond $305/oz. and you haven’t settled your contracts, you will then
have to deliver the gold come delivery date. This would translate into a
loss, since without the contract obligation you could have sold your
gold on the spot market for a higher price than $305/oz. or you could
have sold those futures contracts at that time, which would have fetched
you more than $305/oz.
But what about those times when the underlying commodity has no
price movement? Suppose you buy or sell gold contracts three months
out at $305/oz. and gold prices remain at $300/oz. through the delivery
date. If you bought your contracts for $305/oz., at delivery time you will
be out $5/oz. Offsetting them just prior to delivery won’t help either as
those contract prices would converge to $300/oz. as you get closer to the
delivery date, which means the best price you could get for selling them
would be $300/oz. for a loss of $5/oz. If on the other hand you had sold
the contracts at $305/oz., you would settle your contracts (by going
long) at $300/oz. and pocket the $5/oz. difference. Or on those rare …
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