Selling a contract

Just trying to educate myself on futures and i understand most concepts however there is one issue i wish to clarify upon I am unsure how this person creates the contract to sell, it appears to have just been created out of thin air is this correct:

"Let's say that Sara did some research and came to the conclusion that the price of oil was going to decline over the next six months. She could sell a contract today, in November, at the current higher price, and buy it back within the next six months after the price has declined. This strategy is called going short and is used when speculators take advantage of a declining market.

Suppose that, with an initial margin deposit of $3,000, Sara sold one May crude oil contract (one contract is equivalent to 1,000 barrels) at $25 per barrel, for a total value of $25,000.

By March, the price of oil had reached $20 per barrel and Sara felt it was time to cash in on her profits. As such, she bought back the contract which was valued at $20,000. By going short, Sara made a profit of $5,000! But again, if Sara's research had not been thorough, and she had made a different decision, her strategy could have ended in a big loss."

Sorry if this seems particularly simple. I am clear on buying various contracts with reference to predicted price rises or falls, but am unsure how i would instigate a sale of a contract of this or any sort without owning something already and if this is even possible for an individual to do?

Any help much appreciated

Tom

When you "sell" (go short), you have not actually sold anything...yet. Likewise, when you "buy" (go long), you have not bought anything...yet. What you have done is enter into a contract to sell or buy by the time the contract (March Crude, for example) goes off the board. That margin you put up when entering a contract (position) is not money to purchase. Think of it as a security deposit. When you exit that position, that's when the purchase/sell money changes hands.

Now, shorting:
It works kinda like this:

(There's no margin involved here, because we're not going through a broker. This is personal. Just between you and me.)

(You're about to go short one May Gun Cabinet)
ME: Hey, Tom, I'm looking for an oak gun cabinet. You wouldn't happen to have one you would sell me, would you?

YOU: Gun cabinet?! No, I sure don't. Sorry.

ME: Darn. I really want one. I'd pay 1,000 $mackeroo$ for one. I really need it by May 11th.

YOU: (A light comes on in your head) A thou...!? By M...M...May? YEAH!! I'll get...I've got one.
A thousand bucks?

ME: Yep. Any time by May 11th is fine.

YOU: Done!

You've just entered into a contract to sell me a gun cabinet by May 11th. But you really don't have one. You're short a gun cabinet. You're short one May Gun Cabinet at $1,000.00.

But that light in your head was the idea to go to a yard sale or sumthin' and pick one up for a lot less than a thousand bucks. (Hopefully you will find one for less than a thou, else you lose money on the deal.

Well, you find one for 50, sell it to me for a thousand, you make 950. Except in the futures market, both parts of that deal go down simultaniously. Oh, yeah: and you hafta pay somebody a commission. And in the futures market, you get that margin (deposit) back.

Quote:

but am unsure how I would instigate a sale of a contract of this or any sort without owning something already and if this is even possible for an individual to do?

Gene is completely correct about this. You see what you appear to be forgetting is the time element. You are selling it for future delivery. As long as you have it when it is due there is no problem, future delivery. Short selling brings with it an obligation to deliver in the future, to sell before you buy.

Simply each transaction has a buy and a sell. When you remove the linear time progression, what difference does it make if you buy before you sell, or sell before you buy. All the elements of a transaction still occur. A buyer and a seller make an agreement for consideration.

Also remember that most contracts are never held to expiration for delivery. Only hedgers who deal in the underlying assets will actually want to take delivery (baker) or make delivery (farmer) on the contract. The vast majority of futures contracts are offset (closed out) well before expiration.

As a speculator, you can buy one contract and sell one later and you are flat (out of the market.) Or you can sell one and then buy it back and end up in the exact same place (flat the market.)

So it does not matter if you buy or sell first, so long as you later offset an equal position with the exact opposite trade to your opening position.

Steveo
Manager
www.FuturesStore.com