An Introduction To Trading Silver Futures

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An Introduction To Trading Silver Futures

Silver is the most heavily invested precious metal commodity after gold. Silver has been used as money, jewelry, and as a long-term investment choice for ages. Today, a variety of silver-based products are accessible for trade and investing. These include silver futures, silver options, silver ETFs, and over-the-counter (OTC) products such as silver mutual funds. This article explains how silver futures trading works, how investors commonly utilize it, and what you should know before investing.

The Basics

To illustrate the fundamentals of silver futures trading, consider a maker of silver medals who has won the contract to provide silver medals for an upcoming sporting event. To produce the requisite medals on time, the company will require 1,000 ounces of silver in six months. He analyzes silver pricing and discovers that it is now selling at $10 per ounce. The manufacturer may be unable to acquire the silver today because to a lack of funds, issues with safe storage, or other factors. Naturally, he is concerned about the possibility of a silver price increase in the next six months. He wants to protect himself from future price increases by securing a purchase price of roughly $10. To overcome some of his concerns, the manufacturer might engage into a silver futures contract. The contract might be set to expire in six months, at which point the maker would have the right to acquire silver at $10.1 per ounce. He may lock in the future price by purchasing (having a long position on) a futures contract.

A silver mine owner, on the other hand, anticipates producing 1,000 ounces of silver from her mine in six months. She is concerned that the price of silver may go below $10 per ounce. The silver mine owner may profit by selling (going short on) the above-mentioned silver futures contract, which is now trading at $10.1. It ensures that she will be able to sell her silver at the agreed-upon price.

Assume that each of these players agree to a silver futures contract at a set price of $10.1 per ounce. Depending on the spot price (current market price or CMP) of silver at the time of contract expiration six months later, the following may occur. We’ll go through a few different situations.

In all of the above situations, both the buyer and seller attain their intended price levels for purchasing and selling silver.

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This is a classic example of hedging: utilizing silver futures contracts to provide price protection and so manage risk. The majority of futures trading is done for hedging reasons. The other two trading activity that keep the silver futures market liquid are speculation and arbitrage. Speculators take time-bound long/short positions in silver futures in order to profit from projected price movements, whilst arbitrageurs try to profit on tiny price differentials that exist in the markets in the near term.

Real World Silver Futures Trading

Although the above example is a solid introduction to silver futures trading and hedging, trading in the real world works a little differently. Silver futures contracts with standard parameters are traded on different exchanges across the world. Let’s have a look at how silver trading works on the Comex Exchange (a subsidiary of the Chicago Mercantile Exchange (CME)).

The Comex Exchange provides three types of a basic silver futures contract for trading based on the quantity of troy ounces of silver (1 troy ounce is 31.1 grams).

  • entire (5,000 troy ounces of silver) (5,000 troy ounces of silver)
  • E-mini (2,500 troy ounces)
  • micro(1,000 troy ounces)

A $15.7 price quotation for a whole silver contract (worth 5,000 troy ounces) results in a total contract value of $15.7 x 5,000 = $78,500.

Leveraged futures trading is offered (i.e., it allows a trader to take a position which is multiple times the amount of the available capital).A whole silver futures contract requires a $12,375 fixed price margin. It implies that to take one position in a whole silver futures contract, a margin of just $12,375 is required (rather than the real cost of $78,500 in the preceding example).

Because the entire futures contract margin value of $12,375 may still be too costly for some traders, E-mini contracts and micro contracts are offered at lesser margins in equal quantities. The margin for the E-mini contract (half the size of the full contract) is $6,187.50, while the margin for the micro contract (one-fifth the size of the full contract) is $2,475.

Each contract is backed by physical refined silver (bars) that have been tested for purity of 0.9999 and stamped and serialized by an exchange-listed and certified refiner.

Settlement Process for Silver Futures

Most traders (particularly short-term traders) are unconcerned with delivery techniques. They close off their long/short bets in silver futures around expiration and gain from cash settlement.

Those who retain their positions until expiration will either get or deliver (depending on whether they are the buyer or seller) a 5,000-oz. COMEX silver warrant for a full-size silver future based on their long or short futures contracts. One warrant allows the holder to comparable silver bars in the approved depositories.

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In the case of E-mini (2,500-ounce) and micro (1,000-ounce) contracts, the trader gets or deposits an Accumulated Certificate of Exchange (ACE), which reflects 50% and 20% ownership of a standard full-size silver warrant, respectively. A 5,000-ounce COMEX silver warrant may be obtained by accumulating ACEs (two for E-mini and five for micro).

Role of the Exchange in Silver Futures Trading

Silver forward trade has been around for generations. In its most basic form, it is just two people agreeing on a future price of silver and guaranteeing to settle the deal on a certain expiration date. However, forward trading is not common practice. As a result, it is rife with counterparty default risk.

Trading silver futures on an exchange gives the following benefits:

  • Product standardization for trade (like the size designations of full, E-mini or micro silver contracts)
  • A safe and regulated marketplace where buyers and sellers may engage
  • Insurance against counterparty risk
  • A price discovery process that is effective
  • Future date listing for 60-month ahead dates, allowing for the formation of a forward price curve and, as a result, effective price discovery.
  • Speculation and arbitrage possibilities that do not need the trader to have actual silver but provide the possibility to profit from price differentials.
  • Taking short positions for both hedging and trading
  • Trading hours are sufficiently extended (up to 22 hours for silver futures), providing significant trading possibilities.

Market Participants in the Silver Futures Market

Silver is a well-known precious metal in two markets:

•It is a precious metal for investment

•It has industrial and commercial uses in many products

This makes silver a valuable commodity for a wide range of market players who actively trade silver futures for hedging or price protection. The following companies are important participants in the silver futures market:

•The mining industry

•Refineries

•Electrical and electronics companies

•Photography companies

•Jewelry businesses

•The automobile industry

•Solar energy equipment manufacturers

The aforementioned participants mostly trade silver futures for the purpose of price protection and risk management.

The finance sector is another source of important participants in silver futures markets. These players, who may be interested in speculative and arbitrage possibilities, include:

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•Banks

•Hedge funds and mutual funds

•Proprietary trading firms

•Marketmakers and individual traders

Factors Affecting Silver Futures Prices

Silver prices have seen very significant volatility in recent years, perhaps pushing silver beyond the widely recognized limitations for safe asset classes. As a result, silver is a very volatile commodity to trade.

Around 1990, industrial demand for silver accounted for around 39% of overall demand. The remaining was set aside for investment. At the moment, industrial demand accounts for more than half of overall demand. The major cause of greater volatility in silver prices is growing industrial demand. Silver prices would fall if there was a recession or a decrease in industrial demand.

On the other side, a variety of factors might raise demand for silver, resulting in higher prices. Silver demand would rise as the electronics and car industries expanded. Rising oil costs may raise demand for silver by pushing the adoption of other energy sources such as solar. Silver is used in solar energy equipment. Investors should consider the following factors when attempting to forecast future silver prices:

On the supply side, investigate estimated and actual mine output, particularly in key silver producing nations such as Mexico, China, and Peru.

On the demand side, keep an eye on both industrial and investment demand for silver.

Consider the total economy at the national or global level while studying macroeconomics. Examine the relative performance of other investment vehicles such as gold, the stock market, and oil.

The Bottom Line

In recent years, silver has been a very volatile commodity, making it a high-risk asset. Aside from the variables that influence actual silver prices, silver futures trading is influenced by contango and backwardation effects that are unique to futures trading. In the actual world, futures trading need daily mark-to-market fulfillment. Traders should be aware of this and retain enough funds set up for it. Although small-sized E-mini and micro silver futures contracts with leverage are available, the trading capital requirements for ordinary traders may be greater. Trading silver futures is only recommended for experienced traders who are well-versed in futures trading.

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