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How to Calculate Profits and Losses in Futures Trading?
You must have heard how volatile oil futures can be. You also hear how oil futures went in the negative during the COVID-19 pandemic. But how can that happen? How do you know if that future you have bought is currently at a profit or loss?
Well, let’s read on to find out.
All the concepts covered in this post are taken from section 5 unit 1 of the Quantra course on Futures Trading: Concepts & Strategies. You can preview the concepts taught in this course by clicking on the free preview button.
Note: The links in this tutorial will be accessible only after logging into quantra.quantinsti.com and enrolling for the free preview of the course.
Calculation of profit and loss on futures positions work very differently from other asset classes and before you even start thinking about your strategies, you need to have a complete understanding of this logic.
The good news is that calculating your profit and loss on futures positions is quite simple, as opposed to other types of derivatives. The key thing that you have to know about the futures market you trade is something called the point value. This is sometimes referred to as contract size or multiplier.
Every futures contract represents a certain amount of the underlying asset.
The Comex gold contract represents 100 ounces of gold, Nymex crude oil is 1,000 barrels of oil, corn is 5,000 bushels and natural gas is 10,000 British thermal units.
Sounds confusing?
Well, you do not have to know what a bushel or a British thermal unit is. The units in question do not matter to you as a speculator, but the numbers themselves do.
The number tells you how many dollars you will gain or lose on a contract if it moves by $1.
Imagine that you buy one contract of December 2021 crude oil at $50. Two hours after you bought it, it is trading at $51. Now you have an unrealised gain or open PnL of $1000.
In futures trading, as in all trading and finance, it is important to understand that an unrealised profit or loss is no less real than if it is realised. If you bought 5 contracts of gold at $1481.5 and two days later find that the price is $1479.0, you now have a very real loss of $1250.
The notion that this is not a real loss until you close your position is not only false and contrary to financial principles but also a dangerous delusion. While this concept of valuing assets and liabilities at the last known price, known as mark-to-market, is valid across the entire field of finance, it becomes a little more tangible when it comes to futures. With these particular instruments, the cash settlement is done every day, at the close of trading.
Consider a trader who takes a short position in the S&P 500 June 2021 e-mini future, selling to open 1 contract at $3,900. The point value of this contract is 50, and if you remember, that means that for every $1 the market moves, you gain or lose $50.
On the same day that the trader opened this position, the end-of-day closing price was $3,890. That means that the price of this futures contract changed by $10. We know that the point value for this market is 50, so the change in value was then 500.
The price went down, and the trader was short, so he now has an unrealised gain of $500. But here’s what’s important. At the end of the day, this amount, $500, will be added to his account. It will be transferred to him automatically and show up in the account statement.
The same trader held onto the position for another day and at the end of the second day, the settlement price was $3,950.
What happens now in their account?
The change in his open PnL changed and needs to be settled in cash. What matters here is the change in value since the last mark-to-market settlement, which was a day earlier.
The price change was ($3890 - $3950), which makes -$60. Multiply this by 50 and you arrive at -$3000.
This amount will now be automatically deducted from his cash account. This procedure of daily mark-to-market settlements mitigates risks for all involved parties.
Rather than waiting for contracts to be closed or for the last trading day, this daily settlement makes sure that all parties can meet their obligations.
Sounds interesting? You can calculate the profit and loss in various scenarios by using this Python notebook unit of the Futures Trading: Concepts & Strategies course.
You need to take a Free Preview of the course by clicking on the green-coloured Free Preview button on the right corner of the screen next to the FAQs tab and go to Section 5 and Unit 6 of the course.
I hope this was informative and that you are curious about what kind of trading strategies can be used in the futures market!
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The Futures Trading: Concepts & Strategies course was co-authored by Andreas Clenow, CIO and partner of ACIES Asset Management, author of the best-selling book ‘Following the Trend’.
IMPORTANT DISCLAIMER: This post is for educational purposes only and is not a solicitation or recommendation to buy or sell any securities. Investing in financial markets involves risks and you should seek the advice of a licensed financial advisor before making any investment decisions. Your investment decisions are solely your responsibility. The information provided is based on publicly available data and our own analysis, and we do not guarantee its accuracy or completeness. By no means is this communication sent as the licensed equity analysts or financial advisors and it should not be construed as professional advice or a recommendation to buy or sell any securities or any other kind of asset.
