An introduction to silver trading
After gold, silver is the most invested precious metal. For centuries, silver has been used as currency, jewelry and as a long-term investment option. Various silver-based instruments are currently available for trading and investment. These include silver CFDs, silver futures, silver options, silver ETFs or OTC products such as funds based on silver. This article discusses silver futures trading – how it works, how it is commonly used by investors and what you need to know before trading.
The basics
To understand the basics of silver trading, let’s start with an example of a silver medal manufacturer who has won the contract to provide silver medals for an upcoming sporting event. The manufacturer will need 1000 troy ounces of silver in six months to produce the necessary medals in time.
He checks silver prices and sees that silver is trading today at $26 per ounce. The manufacturer may not be able to buy silver today because he does not have the money, he has problems with safe storage or other reasons. Naturally, he is concerned about the possibility of silver prices rising in the next six months. He wants to protect himself against future price increases and wants to lock the purchase price at around 26 dollars.
The manufacturer can enter into a silver contract to solve some of its problems. The contract may expire in six months, at which time the producer is guaranteed the right to buy silver at $26.1 per ounce. Buying (taking the long position on) a futures contract allows him to lock in the future price.
On the other hand, a silver mine owner expects 1000 ounces of silver to be produced from this mine in six months. He is worried about the price of silver falling (to below $26 per ounce). The silver mine owner can benefit from selling (taking a short position on) the above-mentioned silver futures contract available today at $26.1. This guarantees that she will be able to sell her silver at the fixed price.
Suppose both of these participants enter into a silver futures contract with each other at a fixed price of $26.1 per ounce. At the time of contract expiry six months later, depending on the spot price (current market price or CMP) of silver, the following may occur We go through several possible scenarios.
In all of the above cases, both the buyer/seller achieves to buy/sell silver at the desired price level.
This is a typical example of hedging – achieving price protection and thus managing the risk of silver futures contracts. Most futures trading is for hedging purposes. Moreover, speculation and arbitrage are the other two trading activities that keep silver futures trading liquid. Speculators take time-bound long/short positions in silver futures to take advantage of expected price movements, while arbitrageurs try to exploit small price differentials that exist in the markets in the short term.
Trade in silver
Although the above example provides a good demo of silver futures trading and the use of them to hedge, trading works a little differently in the real world. Silver futures contracts are available for trading on several exchanges worldwide with standard specifications. Let’s see how silver trading works on the Comex Exchange (part of the Chicago Mercantile Exchange (CME) group).
The Comex exchange offers a standard silver contract 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)
E-mini (2500 troy ounces)
Micro (1 000 troy ounces)
At Skilling, it is possible to trade CD contracts of 50 troy ounces.
A price quote of $26.1 for a whole silver contract (worth 5,000 troy ounces) will have a total contract value of $26.1 x 5000 = $130,500.
Futures trading is available on leverage (i.e. it allows a trader to take a position that is several times the available capital). A whole silver futures contract requires a fixed price margin amount of $11,370. This means that one needs to maintain a margin of only $11,370 (instead of the actual cost of $130,500 in the example above) to take a position in an all-silver futures contract. To trade silver with a CD contract requires 113.70 euros at Skilling today.
Since the total contract margin amount of $11,370 may still be higher than some traders are comfortable with, E-mini contracts and micro-contracts are available with lower margins in corresponding proportions. The e-mini contract (half the size of the full contract) requires a margin of half and the micro contract (one fifth the size of a full contract) requires a margin of one fifth.
Each contract is backed by physically refined silver (bars) that are assayed for 0.9999 fineness and stamped and serialized by a listed and approved refiner.
Settlement process for Silver Futures
Most traders (especially short-term traders) are usually not worried about delivery mechanisms. They close their long/short positions in silver futures in time before expiry and benefit from cash settlement.
Those holding their positions to expiry will either receive or deliver (based on whether they are buyers or sellers) 5,000 oz. COMEX silver orders for a full size silver future based on their long or short futures positions.
The role of the stock exchange in silver trading
Forward trading in silver has existed for centuries. In its simplest form, it’s just two individuals agreeing on a future price for silver and promising to settle the trade on a set expiration date. However, forward exchange contracts are not standard. It is therefore full of counterparty risk.
Trading silver futures through an exchange provides the following:
Standardization for trading products (such as size designations for full, E-mini or microsilver contracts)
A safe and regulated marketplace for buyers and sellers to interact
Protection against counterparty risk
An effective price discovery mechanism
Future date listing for 60 months forward dates, allowing the establishment of a forward curve and thus efficient price discovery
Speculation and arbitrage opportunities that do not require any mandatory holding of physical silver by the trader, but still offer the possibility to benefit from price differences
Taking short positions, both for hedging and trading
Sufficiently long hours for trading (up to 22 hours for silver futures), providing ample opportunities to trade on
Who are the players in the silver market?
Silver has been an established precious metal with dual uses
It is a precious metal for investment
It has industrial and commercial uses in many products
This makes silver a commodity of high interest to a variety of market participants who actively trade silver futures for hedging or price protection. The main players in the silver market are:
The mining industry
Refineries
Electrical and electronics companies
Photo companies
The jewelry industry
Automotive industry
Manufacturers of solar energy equipment
The above actors mainly trade silver futures for hedging purposes in order to achieve price protection and risk management.
Another source of key players in the silver market is the financial industry. These players can also work with trading and arbitrage opportunities and include:
Bankers
Hedge funds and mutual funds
Trading companies
Market makers and individual traders
Factors affecting silver prices
Recent years have seen very high levels of volatility in silver prices, possibly pushing silver beyond the widely perceived limits of safe asset classes. This makes silver a very volatile commodity.
Around 1990, industrial demand for silver was around 39% of total demand. The rest was for investment purposes. Currently, industrial demand accounts for over half of total demand. This increased industrial demand is the main driver of increased volatility in silver prices. A recession or slowdown in industrial demand could cause silver prices to fall.
On the other hand, many situations can increase the demand for silver and lead to higher prices. An expansion of the electronics and automotive industries would lead to a higher demand for silver. Rising oil prices may also increase the demand for silver by forcing the use of alternative energy, such as solar power. Solar energy equipment uses silver. To try to predict future silver prices, investors should consider the following:
On the supply side, examine estimated and actual mine production, especially in major silver producing countries such as Mexico, China and Peru.
Follow both industrial demand and silver demand on the demand side.
In macroeconomics, take into account the overall economy at national or global level. Study the relative performance of alternative investment streams including gold, the stock market and oil among others.
Summary
Silver has been a highly volatile commodity in recent years, making it a high-risk asset. In addition to factors affecting physical silver prices, silver futures trading is also affected by contango and backwardation specific to futures trading.
In the real world, futures trading also requires mark-to-market fulfillment on a daily basis. Traders should be aware of this and keep enough capital set aside for it. Although small E-mini and micro silver futures contracts are available with leverage, trading capital requirements can still be high for retail traders which is why CFD contracts are recommended. Trading silver futures is only recommended for experienced traders who have sufficient knowledge of futures trading.
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