Going “short” in the aluminium futures market is a common strategy for speculators anticipating a market decline. Here’s a breakdown of how a short trade works in this scenario.

In futures trading, “going short” means selling contracts based on the belief that prices will drop, allowing the trader to buy back the contracts at a lower price later. Let’s say the current aluminium futures price is $2,600 per tonne, and you wish to trade 1,000 tonnes. Since one aluminium contract on the London Metal Exchange (LME) represents 25 tonnes, trading 1,000 tonnes would require 40 contracts (1,000 tonnes / 25 tonnes per contract).

By shorting 40 contracts at $2,600 per tonne, you’re creating a notional exposure (the total value of your position) of $2,600,000 (40 lots x $2,600 x 25 tonnes).

Before entering this trade, the LME requires an initial margin as a security deposit, which typically represents a fraction of the total exposure. Suppose this margin is just under $200,000. This amount secures your position and covers potential losses.

If the market starts to decline as expected, say the price drops to $2,580 per tonne, you decide to close the position by buying back the contracts. The difference between your initial selling price ($2,600) and the buy-back price ($2,580) results in a profit. Here, each tonne earned $20 (2,600 – 2,580), translating to a $20,000 gain on the 1,000 tonnes traded.

Once you’ve bought back the contracts, the position is closed. You avoid additional margin calls as the position is settled within the same day. The initial margin is released, and you’ll receive your profit when the contracts expire on the third Wednesday of February.

This example illustrates how short selling in the futures market enables traders to leverage price movements, provided they’ve accurately predicted the market trend.