After gold, silver is the most invested precious metal commodity.For centuries, silver has been used as currency, jewelry, and long-term investment choice. Today there are various silver-based tools available for trading and investment. These include over-the-counter products such as silver futures, silver options, silver ETFs or silver-based mutual funds. This article discusses silver futures trading-how it works, how investors typically use it, and what you need to know before trading.
To understand the basics of silver futures trading, let’s start with the example of a silver medal manufacturer who won a contract to provide a silver medal for an upcoming sporting event. Manufacturers will need 1,000 ounces of silver within six months to make the required medals in time. He checked the price of silver and found that today’s silver transaction price is $10 per ounce. The manufacturer may not be able to buy silver today because he has no money, he has security storage issues or other reasons. Naturally, he is worried that silver prices may rise in the next six months. He wants to prevent future price increases and hopes to lock the purchase price at around $10. The manufacturer can sign a silver futures contract to solve some of his problems. The contract may expire in six months, at which time it will guarantee the manufacturer the right to buy silver at $10.1 per ounce. Buying (holding a long position) futures contract allows him to lock in future prices.
On the other hand, the owner of the silver mine expects to produce 1,000 ounces of silver from her mine within six months. She is worried that the price of silver will fall (below $10 an ounce). Silver mine owners can benefit by selling (short positions) the aforementioned silver futures contracts available today at a price of $10.1. It guarantees that she will be able to sell her silver at a set price.
Suppose these two participants sign a silver futures contract with each other at a fixed price of $10.1 per ounce. When the contract expires in six months, depending on the spot price of silver (current market price or CMP), the following may happen. We will introduce several possible scenarios.
In all the above cases, the buyer/seller buys/sells silver at the price level they want.
This is a typical example of hedging-realizing price protection and thus using silver futures contracts to manage risk. Most futures transactions are designed for hedging purposes. In addition, speculation and arbitrage are two other trading activities that maintain the liquidity of silver futures trading. Speculators hold time-limited long/short positions in silver futures to benefit from expected price changes, while arbitrageurs try to take advantage of short-term price differences in the market.
Real world silver futures trading
Although the above example provides a good demonstration of silver futures trading and hedging use, in the real world, trading works slightly differently. Silver futures contracts can be traded on multiple exchanges with standard specifications around the world. Let’s see how silver trading works on Comex Exchange (part of the Chicago Mercantile Exchange (CME) group).
Comex Exchange offers standard silver futures contracts for trading in three variants classified by the number of troy ounces of silver (1 troy ounce is 31.1 grams).
- full (5,000 troy ounces of silver)
- Mini (2,500 troy ounces)
- micro (1,000 troy ounces)
An all-silver contract (worth 5,000 troy ounces) is quoted at $15.7, and the total contract value is 15.7 x 5,000 = $78,500.
Futures trading can be carried out with leverage (that is, it allows traders to hold positions, the amount of which is several times the available funds).A complete silver futures contract requires a fixed price margin of $12,375. This means that you only need to maintain a margin of $12,375 (instead of the actual cost of $78,500 in the example above) to establish a position in a complete silver futures contract.
Since the full futures contract margin amount of US$12,375 may still be higher than the amount accepted by some traders, E-mini contracts and micro contracts are provided at the same proportion of lower margin. The E-mini contract (half of the full contract) requires a margin of US$6,187.50, while the micro contract (one-fifth of the full contract) requires a margin of US$2,475.
Each contract is backed by physical refined silver (bars), with a purity of 0.9999, and is stamped and numbered by a refiner listed and approved by the exchange.
Silver futures settlement process
Most traders (especially short-term traders) usually do not care about the delivery mechanism. They close long/short positions in silver futures in time before maturity and benefit from cash settlement.
Those who hold positions at maturity will receive or deliver (depending on whether they are a buyer or a seller) 5,000 ounces. COMEX Silver Warrants receive full-size silver futures based on their long or short futures positions, respectively. A warrant gives the holder the ownership of equivalent silver bars in the designated depository.
In the case of E-mini (2,500 ounces) and micro (1,000 ounces) contracts, traders either receive or deposit cumulative exchange certificates (ACE), which represent 50% and 20% ownership of the standard full price contract, respectively. Large and small silver warrants. Holders can accumulate ACEs (2 for E-mini or 5 for micro) to obtain 5,000 ounces of COMEX silver warrants.
The role of exchanges in silver futures trading
Silver forward transactions have existed for centuries.In the simplest form, two people agree on the future price of silver and promise to settle the transaction on a set maturity date. However, forward transactions are not standard. Therefore, it is full of risks of counterparty default.
Trading silver futures through the exchange provides the following:
- Standardization of trading products (such as the size designation of all silver, E-mini or micro silver contracts)
- A safe and regulated market for buyers and sellers to interact
- Prevent counterparty risks
- Effective price discovery mechanism
- To be listed on a 60-month forward date in the future, a forward price curve can be established to effectively find the price
- Speculation and arbitrage opportunities that do not require traders to force physical silver holdings, but provide opportunities to benefit from price differences
- Short positions for hedging and trading purposes
- Sufficient trading time (22 hours for silver futures), providing ample trading opportunities
Market participants in the silver futures market
Silver has always been recognized as a precious metal in the dual stream:
• It is a precious metal for investment
• It has industrial and commercial uses in many products
This makes silver a commodity of great concern for market participants who actively trade silver futures for hedging or price protection. The main participants in the silver futures market include:
• mining industry
• Electrical and electronic companies
• Photography company
• Jewelry business
• Automobile industry
• Solar energy equipment manufacturer
The aforementioned participants trade silver futures mainly for hedging purposes to achieve price protection and risk management.
Another source of major participants in the silver futures market is the financial industry. These players may also look for speculation and arbitrage opportunities, including:
• Hedge funds and mutual funds
• Self-operated trading company
• Market makers and individual traders
Factors affecting the price of silver futures
In the past few years, the price of silver has fluctuated greatly, which may push silver to the universally recognized limit of the safe asset class.This makes silver a highly volatile trading commodity.
Around 1990, industry demand for silver accounted for approximately 39% of total demand. The rest is used for investment purposes. At present, industrial demand accounts for more than half of the total demand.The increase in industrial demand is the main factor contributing to the increased volatility of silver prices. The decline or slowdown in industrial demand will lower the price of silver.
On the other hand, many situations may increase the demand for silver and lead to price increases. The expansion of the electronics and automotive industries will lead to increased demand for silver. Rising oil prices may also increase the demand for silver by forcing the use of alternative energy sources such as solar energy. Solar energy equipment uses silver. In order to try to predict the future silver price, investors should consider the following points:
On the supply side, research estimated and actual mine output, especially in major silver producing countries such as Mexico, China and Peru.
On the demand side, we also pay attention to the industrial demand and investment demand of silver.
In macroeconomics, consider the overall economy at the national or global level. Study the relative performance of alternative investment flows, including gold, stock markets, and oil.
In recent years, silver has been a highly volatile commodity, making it a high-risk asset.In addition to the factors that affect the price of physical silver, silver futures trading is also affected by the unique futures premium and spot premium effects of futures trading. In the real world, futures trading also needs to be executed at market prices every day. Traders should be aware of this and allocate sufficient funds for this. Although small E-mini and micro silver futures contracts can be traded with leverage, retail traders still have higher trading capital requirements. Only experienced traders who have sufficient knowledge of futures trading are recommended to trade silver futures.