After gold, silver is probably the most invested precious metal commodity. For hundreds of years, silver has been used as currency, for jewelry, and as an extended term investment option. Various silver-based instruments can be found today for trading and investment. These include silver futures, silver options, silver ETFs, or OTC products like mutual funds based on silver. This text discusses silver futures trading—how it really works, the way it is often utilized by investors, and what you have to know before trading.
The Basics
To know the fundamentals of silver futures trading, let’s begin with an example of a manufacturer of silver medals who has won the contract to offer silver medals for an upcoming sports event. The manufacturer will need 1,000 ounces of silver in six months to fabricate the required medals in time. He checks silver prices and sees that silver is trading today at $10 per ounce. The manufacturer may not find a way to buy the silver today because he doesn’t have the cash, he has problems with secure storage or other reasons. Naturally, he’s anxious in regards to the possible rise in silver prices in the subsequent six months. He wants to guard against any future price rise and needs to lock the acquisition price to around $10. The manufacturer can enter right into a silver futures contract to unravel a few of his problems. The contract may very well be set to run out in six months and at the moment guarantee the manufacturer the appropriate to purchase silver at $10.1 per ounce. Buying (taking the long position on) a futures contract allows him to lock-in the long run price.
Alternatively, an owner of a silver mine expects 1,000 ounces of silver to be produced from her mine in six months. She is anxious in regards to the price of silver declining (to below $10 an oz). The silver mine owner can profit by selling (taking a brief position on) the above-mentioned silver futures contract available today at $10.1. It guarantees that she’s going to have the flexibility to sell her silver on the set price.
Assume that each these participants enter right into a silver futures contract with one another at a set price of $10.1 per ounce. On the time of expiry of the contract six months later, the next can occur depending upon the spot price (current market price or CMP) of silver. We are going to walk through several possible scenarios.
In all of the above cases, each the client/seller achieves buying/selling silver at their desired price levels.
This can be a typical example of hedging—achieving price protection and hence managing the chance using silver futures contracts. Most futures trading is meant for hedging purposes. Moreover, speculation and arbitrage are the opposite two trading activities which keep the silver futures trading liquid. Speculators take time-bound long/short positions in silver futures to learn from expected price movements, while arbitrageurs try to capitalize on small price differentials that exist within the markets for the short term.
Real World Silver Futures Trading
Although the above example provides demo to silver futures trading and hedging usage, in the true world, trading works a bit in a different way. Silver futures contracts can be found for trading on multiple exchanges ac ross the globe with standard specifications. Let’s see how silver trading works on the Comex Exchange (a part of the Chicago Mercantile Exchange (CME) group).
The Comex Exchange offers a regular silver futures contract for trading in three variants classified by the variety of troy ounces of silver (1 troy ounce is 31.1 grams).
- full (5,000 troy ounces of silver)
- E-mini (2,500 troy ounces)
- micro (1,000 troy ounces)
A price quote of $15.7 for a full silver contract (price 5,000 troy ounces) can be of total contract value of $15.7 x 5,000 = $78,500.
Futures trading is accessible on leverage (i.e., it allows a trader to take a position which is multiple times the quantity of the available capital). A full silver futures contract requires a set price margin amount of $12,375. It implies that one needs to take care of a margin of only $12,375 (as a substitute of the particular cost of $78,500 within the above example) to take one position in a full silver futures contract.
Because the full futures contract margin amount of $12,375 should still be higher than some traders are comfortable with, the E-mini contracts and micro contracts can be found at lower margins in equivalent proportions. The E-mini contract (half the scale of the total contract) requires a margin of $6,187.50 and the micro contract (one-fifth the scale of a full contract) requires a margin of $2,475.
Each contract is backed by physical refined silver (bars) which is assayed for 0.9999 fineness and stamped and serialized by an exchange-listed and approved refiner.
Settlement Process for Silver Futures
Most traders (especially short term traders) often aren’t concerned about delivery mechanisms. They square off their long/short positions in silver futures in time prior to expiry and profit by money settlement.
Those who hold their positions to expiry will either receive or deliver (based on in the event that they are the client or seller) a 5,000-oz. COMEX silver warrant for a full-size silver future based on their long or short futures positions, respectively. One warrant entitles the holder the ownership of equivalent bars of silver within the designated depositories.
Within the case of E-mini (2,500-ounce) and micro (1,000-ounce) contracts, the trader either receives or deposits Amassed Certificate of Exchange (ACE), which represents 50 percent and 20 percent ownership respectively, of a regular full-size silver warrant. The holder may accumulate ACE’s (two for E-mini or five for micro) to get a 5,000-ounce COMEX silver warrant.
Role of the Exchange in Silver Futures Trading
Forward trading in silver has been in existence for hundreds of years. In its simplest form, it’s just two individuals agreeing on a future price of silver and promising to settle the trade on a set expiry date. Nonetheless, forward trading will not be standard. It’s subsequently filled with counterparty default risk.
Dealing in silver futures through an exchange provides the next:
- Standardization for trading products (like the scale designations of full, E-mini or micro silver contracts)
- A secure and controlled marketplace for the client and seller to interact
- Protection from a counterparty risk
- An efficient price discovery mechanism
- Future date listing for 60 months forward dates, which enables the establishment of a forward price curve and hence efficient price discovery
- Speculation and arbitrage opportunities that require no mandatory holding of physical silver by the trader, yet offer the chance to learn from price differentials
- Taking short positions, each for hedging and trading purposes
- Sufficiently long hours for trading (as much as 22 hours for silver futures), giving ample opportunities to trade
Market Participants within the Silver Futures Market
Silver has been a longtime precious metal in dual streams:
• It’s a precious metal for investment
• It has industrial and business uses in lots of products
This makes silver a commodity of high interest for a wide range of market participants who actively trade silver futures for hedging or price protection. The most important players within the silver futures market include:
• The mining industry
• Refineries
• Electrical and electronics firms
• Photography firms
• Jewelry businesses
• The car industry
• Solar energy equipment manufacturers
The above players mainly trade silver futures for hedging purpose aimed to attain price protection and risk management.
One other source of the main players in silver futures markets is the financial industry. These players may be in it for the speculation and arbitrage opportunities and include:
• Banks
• Hedge funds and mutual funds
• Proprietary trading firms
• Market makers and individual traders
Aspects Affecting Silver Futures Prices
The previous couple of years have seen very high levels of volatility in silver prices, possibly pushing silver beyond the commonly perceived limits for protected asset classes. This makes silver a highly volatile commodity to trade.
Around 1990, the commercial demand for silver was around 39 percent of total demand. The rest was for investment purposes. At present, industrial demand consists of over half of the full demand. This increased industrial demand is the first factor for increased volatility in silver prices. A recession or slowdown in industrial demand would lower silver prices.
Alternatively, many situations could increase the demand for silver and result in higher prices. An expansion of the electronics and automobile industry would result in a better demand for silver. Increasing oil prices could also increase the demand for silver by forcing the use of other energy, equivalent to solar. Solar energy equipment uses silver. To try to predict future silver prices, investors should consider the next:
On the provision side, study estimated and actual mine production, especially in major silver producing countries like Mexico, China, and Peru.
On the demand side, follow each the commercial demand and investment demand for silver.
In macroeconomics, have in mind the general economy at a national or global level. Study the relative performance of other investment streams including gold, the stock market, and oil amongst others.
The Bottom Line
Silver has been a highly volatile commodity lately, making it a high-risk asset. Aside from aspects affecting physical silver prices, silver futures trading can also be impacted by contango and backwardation effects that are specific to futures trading. In the true world, futures trading also requires mark-to-market success day by day. Traders should concentrate on this and keep sufficient capital allocated for it. Although small-sized E-mini and micro silver futures contracts can be found with leverage, the trading capital requirements can still be higher for retail traders. Trading silver futures is advisable only for knowledgeable traders who’ve sufficient knowledge in futures trading.