If you are looking for an inflation hedge, speculative play, alternative investment class, or trading hedge, gold and silver futures may be a viable way to meet your needs. Trading this market involves substantial risks and is not suitable for everyone, and only risk capital should be used because an investor could lose more than they originally invested. In this article, we will cover the basics of gold and silver futures contracts and how they are traded.
What are precious metal futures contracts?
A precious metals futures contract is a legally binding agreement for the delivery of gold or silver in the future at an agreed price. Contracts are standardized by a futures exchange in terms of quantity, quality, time and place of delivery. Only the price is variable.
Hedgers use these contracts as a way to manage their price risk on an expected purchase or sale of the physical metal. It also gives speculators the opportunity to participate in the markets without any physical backing.
There are two different positions that one can take in the markets. A long position is an obligation to take delivery of the physical metal, and a short (sell) position is an obligation to make delivery. The vast majority of futures contracts are cleared prior to the delivery date. For example, this occurs when an investor with a long position initiates a short position in the same contract, effectively eliminating the original long position.
Advantages of Futures Contracts
Because they are traded on centralized exchanges, futures contract trading offers more financial leverage, flexibility, and financial integrity than actual commodity trading.
Financial leverage is the ability to trade and manage a high market value product at a fraction of the full value. Futures contracts are traded on a margin basis. It requires considerably less capital than the physical market. Leverage provides speculators with a higher risk/higher return investment.
For example, a gold futures contract controls 100 troy ounces, or a brick of gold. The dollar value of this contract is 100 times the market price of one ounce of gold. If the market is trading at $600/ounce, the contract value is $60,000 ($600 x 100 ounces). Based on the trading margin rules, the margin required to control a contract is only $4,050. So for $4,050 one can control $60,000 worth of gold. As an investor, this gives you the ability to leverage $1 to control approximately $15.
In the futures markets, it is just as easy to enter a short position as it is to enter a long position, giving participants a great deal of flexibility. This flexibility gives hedgers the ability to protect their physical positions and allows speculators to take positions based on market expectations.
Exchanges on which gold/silver futures are traded do not offer participants counterparty risk, which is guaranteed by clearing services. This means that the exchange acts as a buyer to each seller, and vice versa, lowering the risks if either party defaults on its responsibilities.
contract specifications
There are a few different gold contracts traded on US exchanges: one on COMEX and two on eCBOT. There is a 100 troy ounce contract that is traded on both exchanges and a mini contract (33.2 troy ounces) that is traded only on the eCBOT.
Silver also has two contracts traded on the eCBOT and one on the COMEX. The ‘big’ contract is for 5,000 ounces, which is traded on both exchanges, while the eCBOT has a mini for 1,000 ounces.
Prayed
Gold is traded in dollars and cents per ounce. For example, when gold is trading at 600/ounce, the contract is worth $60,000 (600 x 100 ounces). A trader who is long 600 and sells at 610 will make $1,000 (610 – 600 = $10 profit, 10 x 100 ounces = $1,000). Conversely, a trader who is long 600 and sells at 590 will lose $1,000.
The minimum price movement or tick size is $0.10. The market can have a wide range, but it must move in increments of at least $0.10.
Both eCBOT and COMEX specify delivery to New York area vaults. These vaults are subject to change by the exchange.
The most active months traded (according to volume and open interest) are February, April, June, August, October and December.
To maintain an orderly market, exchanges will set position limits. A position limit is the maximum number of contracts that a single participant can have. There are different position limits for hedgers and speculators.
Silver
Silver trades in dollars and cents per ounce like gold. For example, if silver is trading at $10/ounce, the ‘big’ contract would be worth $50,000 (5,000 ounces x $10/ounce), while the mini would be worth $10,000 (1,000 ounces x $10/ounce).
The tick size is $0.001 per ounce, which is equivalent to $5 per large contract and $1 per mini contract. The market may not trade in a smaller increment, but it can trade in larger multiples, such as cents.
Like gold, the delivery requirements for both exchanges specify vaults in the New York area.
The most active months for delivery (according to volume and open interest) are March, May, July, September and December.
Silver, like gold, also has position limits set by exchanges.
Hedges and speculators
The primary function of any futures exchange is to provide a centralized marketplace for those who have an interest in buying or selling physical commodities at some point in the future. The metal futures market helps hedgers reduce the risk associated with adverse price movements in the cash market. Examples of hedgers include bank vaults, mines, manufacturers, and jewelers.
Hedgers take a position in the market that is opposite to their physical position. Due to the price correlation between futures and the spot market, a gain in one market can offset losses in the other. For example, a jeweler who is afraid of paying higher prices for gold or silver would buy a contract to ensure a guaranteed price. If the market price of gold/silver goes up, he will have to pay higher prices for gold/silver. However, because the jeweler took a long position in the futures markets, she could have made money on the futures contract, which would offset the increase in the cost of buying gold/silver. If the gold/silver spot price and futures prices were to fall, the hedger would lose on their futures positions, but would pay less to buy their gold/silver in the spot market.
Unlike hedgers, speculators have no interest in taking delivery, but instead try to make a profit by assuming market risk. Speculators include individual investors, hedge funds, or CTAs (commodity trading advisors).
Speculators come in all shapes and sizes and can be in the market for different lengths of time. Those who enter and exit the market frequently in a session are called scalpers. A day trader holds a position longer than a scalper, but usually not overnight. A position trader is held for multiple sessions. All speculators should be aware that if a market moves in the opposite direction, their position may result in losses.
conclusion
If you are a hedger or a speculator, remember that trading involves substantial risk and is not suitable for everyone. Although there can be significant gains for those who engage in trading gold and silver futures, remember that futures trading is best left to traders who have the experience necessary to be successful in these markets.
