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The Top 8 Things You Should Know About Silver Futures

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12 minute read
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For centuries, our ancestors have recognized the beauty and versatility of Silver and even utilized it as jewelry, construction material, as well as a long term investment option. Through the years, countless civilizations, from the Romans and the Greeks to ancient China and South America, have mined Silver and used it for a wide variety of applications, including using Silver bullion to stabilize their currencies. Today, Mexico, Peru, and China currently top the list of the world’s Silver producing countries. It comes as no surprise that there are various Silver-based instruments available today for trading and investing.

Silver is the most invested in precious metal commodity after gold. Thanks to its versatility and many industrial uses, it is also considered a good investment in the futures market. Silver futures were first traded on July 5, 1933, on the Chicago Mercantile Exchange (CME). A Silver futures contract is a legally binding agreement that covers the delivery of Silver at an agreed-upon price in the future. This contract is standardized by a futures exchange as to the time, quality, quantity, and place of delivery, but the price remains variable.

Below, we’ll discuss topics ranging from how Silver futures trading works to why you might consider investing in a Silver futures contract. Here are the top eight things you should know about Silver futures:

  1. The Basics of Silver Futures Trading

    In order to have a clearer understanding of what Silver futures trading is all about, picture yourself as a manufacturer of Silver medals. You just won a lucrative contract to deliver Silver medals for the next Olympics and are currently gearing up to launch production. You need 1,000 ounces of Silver in six months to be able to manufacture all the medals in time, so you check the prices of Silver and see that it is trading at $15 per ounce. For one reason or another (insufficient cash on hand, inadequate storage space, etc), you are unable to purchase all that Silver today. Naturally, you’re worried about how the current Silver price may rise in the next six months.

    Medal manufacturer

    • You need 1,000 ounces of silver
    • You are worried about how prices may increase in the next 6 months
    • You can benefit by buying the above-mentioned Silver futures contract available today at $15
    Silver mine owner

    • You haven’t mined 1,000 ounces of silver yet
    • You are worried about how prices may decrease in the next 6 months
    • You can benefit by selling the above-mentioned Silver futures contract available today at $15

    In order to protect against any future price increase, you decide to lock the purchase price at around $15 per ounce by entering into a six month Silver futures contract. By buying the futures contract, you can then lock in the future price so that by the expiry of the contract you are guaranteed to buy your 1000 ounces of Silver at only $15 per ounce. Problem solved.

    Now consider the other side of the trade. Picture yourself as the owner of a Silver mine and a manufacturer approaches you, intending to purchase 1,000 ounces of Silver in six months’ time. You’re concerned about the price of Silver declining to below its current price of $15 per ounce. You can benefit by selling the above-mentioned Silver futures contract available today at $15. This guarantees that you will have the ability to sell your Silver at the set price. At the time of expiry of the contract, six months from now and regardless of how the prices have changed, both the manufacturer and the Silver mine owner walk away satisfied with the business that was concluded.

  2. Where Are Silver Futures Traded?

    Silver futures are traded on the following exchanges:
    • Commodities Exchange (COMEX): This is a division of the Chicago Mercantile Exchange (CME) group. On this exchange, Silver futures contracts are for 5,000 or 1,000 troy ounces and have a variety of expiration dates.  At expiration, the contracts are settled through physical delivery of the Silver. COMEX provides its market participants, including producers, end-users, hedge funds, banks, proprietary trading firms, and active individual trader, with a central point of price discovery and price transparency, as well as risk mitigation of counterparty credit risks.
    • London Metal Exchange (LME): This exchange offers Silver forwards curve data to any investor looking to sign up. As an investor, you will be able to see one-week forward curves as well as up to 36 months forward. Contracts can be traded electronically via the LMEselect as well as through the 24-hour inter-office telephone market of the exchange.
    • Multi-Commodity Exchange (MCX): The MCX is based in India and as of 2011, it was ranked number one for Silver trading since it offers just two different contracts. The maximum order size is pegged at 600 kg with a daily base price limit of 4%. Standard Silver futures represent 30 kg and are traded in the months of March, May, July, September, and December.
  3. Why Are These Exchanges Needed in Silver Futures Trading?

    You’re probably wondering why a buyer and a seller cannot simply meet, discuss terms, and agree on a future price of Silver with the promise of settling the trade on a set expiry date. This method is actually called forward trading and has been in existence for a pretty long time. The problem with forward trading is that it is not standard and therefore presents counterparty default risk. This simply means that there is always the likelihood or probability that one party might default on its contractual obligation, especially since there is no governing body regulating the transaction. Hence the need to deal in Silver futures through an exchange. This provides the following benefits:

    • Standardization for products that are to be traded.
    • A secure and regulated marketplace when buyers and sellers can transact.
    • Protection from counterparty risk.
    • More efficient price discovery and price transparency mechanism.
    • Speculation and arbitrage opportunities. Even if a trader doesn’t currently have any physical Silver, he or she can still gain exposure to Silver price fluctuations.
    • Ample amount of trading opportunities since exchanges are open for long hours (up to 22 hours for Silver futures).
  4. Calculating and Trading Silver Futures

    When trading Silver futures on COMEX, each contract would specify the price for the delivery of 5,000 or 1,000 troy ounces of 999 fineness Silver during an agreed-upon delivery period at a licensed depository. Some CME approved depositories for the storage of Silver deliverables when a futures contract settles include Brinks Inc., CNT Depository Inc., JP Morgan Chase Bank NA, International Depository Services of Delaware, HSBC Bank USA, and Malca-Amit USA, LLC. These contracts are marked to market daily, such that the profit or loss for the day is added to or subtracted from the cash balance in your brokerage account.

    Product Symbol SI
    Venue CME Globex, CME ClearPort, Open Outcry (New York)
    Contract Size 5,000 troy ounces
    Price Quotation U.S. dollars and cents per troy ounce
    Trading Hours Sunday – Friday 5:00 PM – 4:00 PM Chicago Time with a 60-minute break each day beginning at 4:00 PM Chicago Time
    Minimum Price Fluctuation Outrights: 0.005 per troy ounce = $25.00
    Spreads: 0.001 per troy ounce = $5.00
    Trading Termination Trading terminates at 12:25 PM Chicago Time on the third last business day of the delivery month.
    Delivery Period Actual delivery can be done on any business day beginning on the first business day of the delivery month or any subsequent business day within that delivery month. However, it must not be later than the last business day of the designated delivery month.
    Grade And Quality All Silver delivered under this contract shall be appraised at a minimum of 999 fineness.

    Source:CME

    When trading, you’ll want to start by identifying a contract expiration month. To enter a long position, place a bid on the CME Globex system to purchase one or more contracts of the specific expiration month. For instance, let’s say your accepted bid for a six-month contract is $25.50 per ounce, the value of your contract will be $127,500 for 5,000 ounces. Alternatively, you can go take a short position by placing an offer to sell contracts on Globex. Keep in mind, however, that your futures brokerage account must have sufficient cash to meet the CME’s initial margin deposit requirement per contract.

    Precious metal fineness

    • Fineness expressed in units of parts per 1,000.
    • It represents the weight of fine metal therein, in proportion to the total weight.
    • The rest includes alloying base metals and any impurities

    The good thing about futures contracts is that you don’t need to have the entire amount of the contract value in order to trade. Instead, you only need to put up the margin deposit, a good-faith deposit to make good on the contract. This potentially allows investors to make significant returns on their investment due to leverage, but may also result in large losses. That’s why leveraged instruments are not suitable for all investors.

  5. Why You Might Consider Investing in Silver Futures

    Investors purchase Silver for a variety of reasons, but the following are some of the most common ones:

    • Silver is a physical asset – As an investor, how many of your investments can you actually hold in your hand? In today’s world of digital trading and paper profits, having an asset that you can carry in your pocket anywhere you go or store in your safe is not just a good way to diversify your portfolio, but is also a good way to mitigate certain risks. For instance, physical Silver is immune to hacking and cybercrime. Also, it can provide a buffer or store of value for your finances during economic crises. In most cases, Central Banks react to crises by lowering interest rates so that there is an increase in the money supply. This can weaken currencies and diminish investor confidence in the stock and bond markets. Since Silver is a physical scarce asset with a limited above-ground supply, it is far more likely to hold its value during periods of turmoil.
    • Speculating on the industrial strength of Silver in the global economy – From manufacturing and automobile to jewelry and household items, Silver is used across many industries today, so its strength in the global economy should translate to higher prices. As these and other emerging markets continue to grow, the demand for Silver could experience a rapid increase, which in turn, will affect its price. If you were to invest in Silver now, you could stand to make significant profits when the demand eventually soars.
    • Betting on diminishing supply – This is one of the most attractive reasons to invest in Silver today. High mining costs combined with depressed prices for Silver have led to lower production numbers in recent years. Unless these factors change, many Silver mining projects will remain on hold. Limited supply could be a recipe for higher prices down the line.
    • Silver is relatively cheap – Silver is cheaper than gold, so an investor can own more Silver for less capital. This makes it a potentially popular choice for lower capitalization investors. Silver is also more volatile than many other assets. This can make it a potentially lucrative investment for active investors looking to capitalize on its price swings since they can sometimes lead to sharp upward movements.
  6. Factors Affecting Silver Futures Prices

    In order to understand the global pricing trends for Silver, the first thing you need to consider is demand and supply. Unlike gold where the demand predominantly comes from the need for jewelry, investment and store of value, the demand and supply for Silver are somewhat different. Nearly 85% of Silver is supplied from Silver mines around the world while the remainder comes from recycled scrap. This means:

    On the supply side,

    • Silver mines are concentrated in certain countries like Mexico, China, Kazakhstan, and Peru. Any disruption in the supply from these key mines will impact the price of Silver on a global scale.
    On the demand side,

    • Silver is used in a wide variety of applications across different industries. Therefore, increased production and new manufacturing facilities will almost certainly push prices up due to the spurt in demand.
    Other factors include:
    • Strength of the US dollar: The dollar tends to have an inverse relationship with the price of Silver. The stronger the dollar, the more pressure it places on the price of Silver.
    • Increasing oil prices: This, among other environmental factors, has led to an increase in the demand for alternative energy, such as solar.  A lot of solar energy equipment is made with Silver. Hence this could impact demand on a large scale.
    • Large and private institutional investors: Investors with deep pockets can influence the demand and price of Silver. For instance, Silver Thursday was when the Hunt brothers almost cornered the global Silver market. They leveraged their Silver positions and pushed the price through the roof. Other investors, like Warren Buffett who purchased 130 million troy ounces in 1997, and iShares which held roughly 180 million ounces of Silver as of 2008, have the power to affect market prices as well.
    • Stock market fluctuation: There is definitely some interplay between how the stock markets fare and the amount of capital that flows into Silver. While it is not set in stone, the appeal of Silver as an alternative asset tends to increase when traditional investments like stocks and bonds are not faring well.
    • Gold Prices: Despite all the other fundamental drivers of Silver, gold is still considered as the primary driver for the price of Silver. When the commodity market turns bullish, speculators tend to be interested in precious metals, predominantly gold. This increased demand often extends to Silver as well, which raises its price. At the same time when the commodity market is bearish and investors lose confidence in gold, the price of Silver tends to go down as well.
  7. Important Trading Tips for Silver Futures

    Here are some helpful rules that you should follow when trading Silver futures so you can limit risk and maximize return:

    • Understand the lingo: Trading Silver futures contracts without knowing the various terminology involved is like driving blindfolded on a curvy road. By becoming familiar with the futures contract lingo, you are able to understand the trades you’re making and avoid potentially costly mistakes. At the very least, you should know these two terms:
      • Convergence – This refers to the tendency for the futures price to approach the spot price in the market as the delivery date looms closer.
      • Maintenance Margin: – This is the amount of money you need to hold on to a futures contract. If you fail to maintain this amount, you get a margin call and need to put up additional capital to cover the margin. Your broker could close your position if you fail to put up the additional capital.
    • Invest in Silver futures as a small part of a broader investment portfolio (diversification): In recent years, the increased industrial demand for Silver has caused increased volatility. Its price has been rising and falling with much greater frequency than gold and other traded precious metals. This level of volatility presents a lot of opportunity for seasoned and knowledgeable traders to correctly time their investments and gain some significant turnarounds. However, if you don’t have the risk appetite and trading knowledge for this kind of venture, you can always invest in Silver futures contracts as only a small part within your portfolio. This can help diversify your portfolio and hedge it against big pullbacks in the stock market.
    • Have a system for managing leverage-related risks: Silver futures contracts are leveraged instruments. Therefore, there’s always the risk of losing more money than the actual worth of the futures position. To mitigate this risk, watch the volatility of Silver prices carefully. You can also use spreads to offset losses on one trade with gains in another trade. This involves buying a Silver futures contract at one strike price and selling another contract at another strike price.
  8. What is the Settlement Process for Silver Futures?

    If you are trading Silver futures, especially as a short-term trader, you’re probably not concerned about the delivery mechanism. You can simply close your long or short Silver futures position in time before the contract expires and rake in the benefits or losses through a cash settlement. However, if you are planning to hold your position until the expiry of the futures contract, then you’re looking at either receiving or delivering (depending on if you’re the buyer or seller) a 5,000-oz COMEX Silver warrant for a full size silver futures contract. This warrant entitles you or the counterparty of the transaction to the ownership of equivalent Silver bars in your designated depository. In the case of the micro (1,000 ounce) contracts, you will either receive or deposit an Accumulated Certificate of Exchange (ACE), which represents 20% ownership of a standard full-size Silver warrant. You may then accumulate five ACE’s to get a 5,000-ounce COMEX Silver warrant.

Should You Consider Silver Futures Contracts as an Investment?

Silver futures investing can be a solid addition to any portfolio but only if done in carefully measured quantities. As a hedging asset, Silver can deliver a steady, diversified return compared to traditional stocks, especially in times of economic downturns and rising inflation. Amid increasing speculation of a bullish market looming on the horizon for Silver futures, this might be the ideal time to give it a second look. Nevertheless, you should be careful about taking large speculative options on Silver or other precious metals. Silver is highly volatile and if it makes up the bulk of your portfolio, your entire investment may be rocked by its turbulent price swings. As with every other investment, a proper understanding of the market and its core drivers is key to a successful venture.

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