From the course: Derivatives Fundamentals
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Analyzing forward contract profit and loss diagrams
From the course: Derivatives Fundamentals
Analyzing forward contract profit and loss diagrams
- [Presenter] Let's now look at forward contract profit and loss diagrams. On the left, you see the profit and loss or payoff diagram for a long position in a forward contract, and on the right you see the profit and loss or payoff diagram for a forward contract short position. Let's talk through the diagram on the left with an example. So let's imagine you are buying oil, and you've agreed to lock in the price of a barrel of oil now at $50 a barrel for delivery in one year's time. So remember, you're buying the oil. Now let's fast forward a year. We now are coming to the end of the contract, the expiration, and now we're going to buy the oil for $50 a barrel. However, the spot price of oil at the time, this is one year in the future, let's say it's now 55. We've now made a profit of $5 on each barrel of oil because we're buying the oil at our locked in price of $50, whereas if we had to buy that oil in the spot market, we'd be paying $55 a barrel. So let's get into a worked example…
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