How to Open A Long Position

Written by Aaron Adam

If you believe a commodity or financial instrument's value is going to increase, you can make a profit on the eventual rise of this underlying asset by adopting a long position in the futures market. In simple terms, a long position is a bet that the value of the underlying asset being traded will increase. Like any other investment, adopting a long position in the futures market involve some risk. But with experience and good research, you can stack the odds more highly in your favor.

When you take a long position in the futures market, you're basically buying a futures contract with the expectation that the underlying asset will rise in value by the delivery date of the contract. Non-speculative buyers also take up long positions. These traders buy futures contracts to lock in a current price on a commodity because they believe that commodity's price will jump by the time they take delivery on the contract. For example, a trucking company, expecting a spike in gasoline prices, may enter into a futures contract for fuel in order to lock in a lower price than what they're predicting for the future.

To open a long position in the futures market, you need a trading account on a futures exchange. There are several futures markets around the country, with perhaps the most prominent one being the CME Group. The CME Group was formed in 2007 after a merger of two other futures exchanges. CME also recently acquired the NYMEX, or New York Mercantile Exchange, the word's largest physical commodity exchange. Billions of dollars worth of agricultural commodities, energy products, metals and other commodities are traded in the CME Group each year. These commodities can be traded on the exchange floor or through electronic trading systems.

Going long on futures

Here's an example of an investor going long on the futures market:

An investor decides to go long on a near-month wheat futures contract valued at about $20 per bushel. The contract is for 1,000 bushels, so the contract is worth $20,000. If you're trading on margin, you won't be required to pay the full value of the contract. Instead, you'll put up about $5,800 on the contract to open a long position.

For our purposes, let's say that the price of wheat increases to $25 per barrel in before the delivery date on your contract. Your contract is now worth $25,000. If you sell, you can leave your long position and realize a profit of about $5,000 before taxes. Although the price of wheat has only bumped up about 20 percent, you've realized a much larger return on investment because you only had to pony up $5,800 to get control of the 1,000 bushels of wheat.

However, let's say the market went against you. If the price of wheat had dropped, you would have had to cover the margin requirements in order for you to keep your long position open in a margin call.

How margin calls impact futures contracts

Let's take a look at how margin calls impact futures contracts.

Let's say an investor has $10,000 in his trading account. The investor then decides to purchase a wheat futures contract valued at about $15 per barrel. The contract is for 1,000 bushels of wheat and the initial margin is $8,000 and the maintenance margin is about $7,000. Because the investor has $10,000 in his account, he has sufficient funds to open a long position.

Unfortunately for the investor, the price of wheat dips to $10 per barrel, an open position loss of $5,000. Therefore the value of his account balance dips. He may be subject to a margin call, which means he'll have to top his account back to the maintenance margin requirement in order to keep his position open.

As illustrated, taking a long position in futures is a high risk, high reward investing strategy. This type of trading is not for novice investors, and folks wishing to engage in this sort of trading should seek the advice of a broker before venturing into the market. That said, for more experienced investors, futures trading has spectacular potential for growth.