Futures Contracts Return from Investing

The only type of return received at investing in futures contracts is in the way of profits and losses of capital. Futures contract holders will not receive income whatsoever.

Investors in futures contracts put a small fraction of the total cost of the contract which is the required margin. Consequently, if great price changes  take place in the underlying commodity or financial security, the required margin to the investor can duplicate or be eliminated within a short period of time.

The following equation illustrates how to determine return in an investment in futures contract. The return is based in the amount invested (margin deposit) and not at the total value of the contract. It is this leverage which magnifies the returns or potential losses with these contracts.

                                              Selling price of futures contracts –
Return on investment =
   Purchase price of futures contract
                                
          Margin deposit

Let’s pretend that you bought 2 gold futures contracts at $400 ($400 per troy ounce), needing an initial margin of $2700 ($1350 per contract). These two contracts control 200 troy ounces of gold with an $80,000 cost (2 x 100 x $400). If you close up your contract when raising the price to $412, your return over invested capital would be 89%:

                                             Selling price of futures contract -
Return on investment =
Purchase price of futures contract
                                     
     Margin deposit

      = $82,400 - $80,000
                   2,700
      = 89%

The return of 89% is mainly due to leverage. The required amount for the initial margin that was invested was only of 3.38% of the total value of the paid price for the contract, while the gold contract only raised 3% ($12 / $400).

If the commodity price falls below the buying price, the leverage works as a two edge sword in which the losses would also be magnified.

Let’s pretend that you closed out your position in two gold contracts when the prices decline to $393 and instead of making an additional funds deposit as required by the margin call. Your loss would be 52%:

                                           Selling price of futures contracts –
Return on investment = Purchase price of futures contracts
                                          Margin deposit

    = $78,600 - $80,000
                 2,700
    = -52%