Sunday, January 27, 2008

Silver Futures

Silver Futures can be a confusing subject for many people. After all what has it to do with how to buy silver? To understand silver futures, one needs to understand firstly what a futures contract is.

What is a Futures Contract
A futures contract is a contract, traded on a special stock exchange called a futures exchange. The idea is to buy or sell, what is called, a certain underlying instrument, in this case silver, at a certain date in the future, at a specified price. Basically it is a bet that something will be worth something at sometime in the future. This gives new meaning to the word nebulous as no one can predict with accuracy what the value of a commodity will be at some date in the future. You can, of course, find heaps of experts that give advice or guidance but, intimately, no one really knows what the price is going to be.

Obligations of a Futures Contract
A futures contract is different to an option. Whereas with an option the holder simply has an option to buy or sell, the futures contract contains, as part of the contract, an obligation. You are required by law, in other words, to pay.

Both parties of a futures contract must fulfill the contract on the settlement date unless you opt to roll over in to the next months contract. Then cash is transferred from the futures trader who sustained a loss to the one who made a profit. Most futures trading is done on a cash settlement basis these days.

Do Future Traders Lose Money?
The US department of Agriculture did a study one time and found that 75% of people that speculated in futures in agricultural commodities lost their money.

In fact many investors have lost entire fortunes speculating in futures.

What are Silver Futures?

Silver futures are simply futures contracts where the commodity is silver. This is usually in the form of weight.

Futures contracts, or simply futures, for silver are usually 5000 troy ounces, One would trade in parcels or multiples of 5000 troy ounces, (although In November 2006, the National Commodity and Derivatives Exchange (NCDEX) in India introduced 5 kg silver futures) and the exchanges clearinghouse would act as counterparty on all contracts, setting margin requirements, and so forth.

Silver futures and options, currently trade on many exchanges around the world. In the U.S. it is primarily traded on COMEX (Commodity Exchange), a subsidiary of the New York Mercantile Exchange. Other major trading countries all have own futures and options (called derivatives) trading floors.

In short, silver futures are a bet that the price of silver is going to be at a specific price at some time in the future. This could be a high or a low price. If you are wrong you have to cough up the money, if you are right, you get the funds to the value of the current silver price on settlement day from the other trader

How Does a Silver Futures Contract Work
You simply agree to buy, say for example 1000 ounces of silver, in three months to the day at 6 dollars per ounce on that day. That future date is called the delivery date or final settlement date. The pre-set price is called the futures price. The price of the underlying asset on the delivery date is called the settlement price. If an ounce of silver on that day is worth 10 dollars, you win as you are only paying 6 dollars for an ounce of silver that is considered to be worth 10 dollars. You would have made 4 dollar an ounce profit. and the seller loses as you are only paying 6 dollars for something that is worth 10 dollars. If the price of silver goes down in the interim to 3 dollars, then you will find yourself paying 6 dollars for something worth only 3 dollars. That is a nasty situation to say the least. You will have lost half your money! Of course you do not get the silver. It is all a cash transaction so you cannot, if you lose, collect the silver and hold onto it in the hope it will go up again and you can sell it. However t you can roll it over into another contract.

The big issue here is the leverage. You don't have to pay up front all that you are buying,. Only a percentage of between 1 and 10 percent. Of course if you win you can win a lot of money. Most people lose and that means they do not just lose the 1000 dollars they put down but the entire amount they bet.

e.g. 5000x16.7USD (shall we say, is equal to 835900USD traded. So you only pay 835US Dollars with a 100:1 margin and control 83500 worth of silver. But if the price goes down by just 1 percent, you have now lost your initial cost of purchasing the futures contract and if it goes down by even more, such as 10 percent, as can happen in a flash, you start to lose some serious money. If you don't have sufficient funds in your account, and this happens to so many people, you are liquidated immediately if you cannot met the margin call within a few minutes.

You have to have sufficient funds to back up your call so you can ride out the dramatic changes that can occur from one moment to the next.

This is all done on a cash basis in most markets and in practice you would be working with a dealer so there is no "taking the silver and run."

This explains why silver futures traders are usually professional dealer with large capital bases who are buying and selling for large institutions. And even they can lose big time.

Quite honestly you would have a far better chance of winning at the casino.

Should you Buy Silver Futures?
Our advice is to not trade in silver futures unless you have many years of experience, more money than you could ever possibly want and a devil may care attitude. Silver futures require considerable experience and knowledge and even then, many an expert trader has come unstuck trading futures.

In answer to the question, should you buy silver futures, the short answer is no.

One should not buy silver futures, one should buy silver bullion instead.

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