If you are looking for a hedge against inflation, a speculative play, an alternative investment class or a commercial hedge, gold and silver futures contracts can be a viable way to meet your needs. In this article, we'll cover the basics of gold and silver futures contracts and how they are traded. But be forewarned: Trading in this market involves substantial risks, and investors could lose more than they originally invested.

Tutorial: Futures Fundamentals

What Are Precious Metals Futures Contracts?
A precious metals futures contract is a legally binding agreement for delivery of gold or silver in the future at an agreed-upon price. The contracts are standardized by a futures exchange as to quantity, quality, time and place of delivery. Only the price is variable. (For more insight, see the Futures Fundamentals tutorial.)

Hedgers use these contracts as a way to manage their price risk on an expected purchase or sale of the physical metal. They also provide speculators with an opportunity to participate in the markets without any physical backing.

There are two different positions that can be taken: A long (buy) position is an obligation to accept delivery of the physical metal, while a short (sell) position is the obligation to make delivery. The great majority of futures contracts are offset prior to the delivery date. For example, this occurs when an investor with a long position initiates a short position in the same contract, effectively eliminating the original long position.

Advantages of Futures Contracts
Because they trade at centralized exchanges, trading futures contracts offers more financial leverage, flexibility and financial integrity than trading the commodities themselves. (For related reading, check out Commodities: The Portfolio Hedge.)

Financial leverage is the ability to trade and manage a high market value product with a fraction of the total value. Trading futures contracts is done with performance margin. It requires considerably less capital than the physical market. The leverage provides speculators a higher risk/higher return investment. (For related reading, see The Leverage Cliff: Watch Your Step.)

For example, one futures contract for gold controls 100 troy ounces, or one brick of gold. The dollar value of this contract is 100 times the market price for one ounce of gold. If the market is trading at $600 per ounce, the value of the contract is $60,000 ($600 x 100 ounces). Based on exchange margin rules, the margin required to control one contract is only $4,050. So for $4,050, one can control $60,000 worth of gold. As an investor, this gives you the ability to leverage $1 to control roughly $15.

In the futures markets, it is just as easy to initiate a short position as a long position, giving participants a great amount of flexibility. This flexibility provides hedgers with an ability to protect their physical positions and for speculators to take positions based on market expectations. (For related reading, see What is the difference between a hedger and a speculator?)

The exchanges in which gold/silver futures are traded offer participants no counterparty risks; this is ensured by the exchanges' clearing services. The exchange acts as a buyer to every seller and vice versa, decreasing the risk should either party default on its responsibilities.

Futures Contract Specifications
There are a few different gold contracts traded on U.S. exchanges: One at COMEX and two on eCBOT. There is a 100-troy-ounce contract that is traded at both exchanges and a mini contract (33.2 troy ounces) traded only at the eCBOT.

Silver also has two contracts trading at the eCBOT and one at the COMEX. The "big" contract is for 5,000 ounces, which is traded at both exchanges, while the eCBOT has a mini for 1,000 ounces.

Gold Futures
Gold is traded in dollars and cents per ounce. For example, when gold is trading at $600 per ounce, the contract has a value of $60,000 (600 x 100 ounces). A trader that is long at 600 and sells at 610 will make $1,000 (610 – 600 = $10 profit, 10 x 100 ounces = $1,000). Conversely, a trader who is long at 600 and sells at 590 will lose $1,000.

The minimum price movement or tick size is 10 cents. The market may have a wide range, but it must move in increments of at least 10 cents.

Both the eCBOT and COMEX specify delivery to New York area vaults. These vaults are subject to change by the exchange.

The most active months traded (according to volume and open interest) are February, April, June, August, October and December.

To maintain an orderly market, the exchanges will set position limits. A position limit is the maximum number of contracts a single participant can hold. There are different position limits for hedgers and speculators.

Silver Futures
Silver is traded in dollars and cents per ounce like gold. For example, if silver is trading at $10 per ounce, the "big" contract has a value of $50,000 (5,000 ounces x $10 per ounce), while the mini would be $10,000 (1,000 ounces x $10 per ounce).

The tick size is $0.001 per ounce, which equates to $5 per big contract and $1 for the mini contract. The market may not trade in a smaller increment, but it can trade larger multiples, like pennies.

Like gold, the delivery requirements for both exchanges specify vaults in the New York area.

The most active months for delivery (according to volume and open interests) are March, May, July, September and December.

Silver, like gold, also has position limits set by the exchanges.

Hedgers and Speculators in the Futures Market
The primary function of any futures market is to provide a centralized marketplace for those who have an interest in buying or selling physical commodities at some time in the future. The metal futures market helps hedgers reduce the risk associated with adverse price movements in the cash market. Examples of hedgers include bank vaults, mines, manufacturers and jewelers. (For more insight, see A Beginner's Guide To Hedging.)

Hedgers take a position in the market that is the opposite of their physical position. Due to the price correlation between futures and the spot market, a gain in one market can offset the losses in the other. For example, a jeweler who is fearful that she will pay higher prices for gold or silver would then buy a contract to lock in a guaranteed price. If the market price for gold/silver goes up, she will have to pay higher prices for gold/silver. However, because the jeweler took a long position in the futures markets, she could have made money on the futures contract, which would offset the increase in the cost of purchasing the gold/silver. If the cash price for gold/silver and the futures prices both went down, the hedger would lose on her futures positions, but pay less when buying her gold/silver in the cash market.

Unlike hedgers, speculators have no interest in taking delivery, but instead try to profit by assuming market risk. Speculators include individual investors, hedge funds or commodity trading advisors.

Speculators come in all shapes and sizes and can be in the market for different periods of time. Those who are in and out of the market frequently in a session are called scalpers. A day trader holds a position for longer than a scalper does, but usually not overnight. A position trader holds for multiple sessions. All speculators need to be aware that if a market moves in the opposite direction, the position can result in losses. (For more insight, see Introduction To Types Of Trading: Scalpers, How To Scalp Fundamentally and Scalping: Small Quick Profits Can Add Up.)

The Bottom Line
Whether you are a hedger or a speculator, remember that trading involves substantial risk and is not suitable for everyone. Although there can be significant profits for those who get involved in trading futures on gold and silver, remember that futures trading is best left to traders who have the expertise needed to succeed in these markets.

Related Articles
  1. Mutual Funds & ETFs

    ETF Analysis: iShares Gold Trust

    Learn about the SPDR Gold Shares ETF, how it tracks the price of gold, and what type of investors may want to hold shares in their portfolios.
  2. Professionals

    A Day in the Life of a Hedge Fund Manager

    Learn what a typical early morning to late evening workday for a hedge fund manager consists of and looks like from beginning to end.
  3. Credit & Loans

    Pre-Qualified Vs. Pre-Approved - What's The Difference?

    These terms may sound the same, but they mean very different things for homebuyers.
  4. Options & Futures

    Cyclical Versus Non-Cyclical Stocks

    Investing during an economic downturn simply means changing your focus. Discover the benefits of defensive stocks.
  5. Insurance

    Cashing in Your Life Insurance Policy

    Tough times call for desperate measures, but is raiding your life insurance policy even worth considering?
  6. Fundamental Analysis

    Using Decision Trees In Finance

    A decision tree provides a comprehensive framework to review the alternative scenarios and consequences a decision may lead to.
  7. Financial Advisors

    Are Alternatives Right for Your Portfolio?

    Alternative investments are increasingly making their way into retail investors' portfolios. Are they a good fit?
  8. Options & Futures

    Why Gold Is No Longer the Currency King

    Although a gold standard seems like a good idea, looking at its role in U.S. history reveals that it may not be the beacon of stability that it claims.
  9. Bonds & Fixed Income

    Credit Default Swaps: An Introduction

    This derivative can help manage portfolio risk, but it isn't a simple vehicle.
  10. Options & Futures

    Understanding The Escrow Process

    Learn the 10 steps that lead up to closing the deal on your new home and taking possession.
  1. Can hedge funds trade penny stocks?

    Hedge funds can trade penny stocks. In fact, hedge funds can trade in just about any type of security, including medium- ... Read Full Answer >>
  2. Are hedge funds regulated by FINRA?

    Alternative investment vehicles such as hedge funds offer investors a wider range of possibilities due to certain exceptions ... Read Full Answer >>
  3. Should mutual funds be subject to more regulation?

    Mutual funds, when compared to other types of pooled investments such as hedge funds, have very strict regulations. In fact, ... Read Full Answer >>
  4. Can hedge fund returns be replicated?

    You can replicate hedge fund returns to a degree but not perfectly. Most replication strategies underperform hedge funds ... Read Full Answer >>
  5. Can foreign investors invest in US hedge funds?

    U.S. hedge funds are open to accredited investors. When they distribute profits to investors, those proceeds are taxed at ... Read Full Answer >>
  6. Do hedge funds manipulate stock prices?

    Some economics professors think there is evidence of manipulation of certain stocks by hedge funds on key reporting days. ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Turkey

    Slang for an investment that yields disappointing results or turns out worse than expected. Failed business deals, securities ...
  2. Barefoot Pilgrim

    A slang term for an unsophisticated investor who loses all of his or her wealth by trading equities in the stock market. ...
  3. Quick Ratio

    The quick ratio is an indicator of a company’s short-term liquidity. The quick ratio measures a company’s ability to meet ...
  4. Black Tuesday

    October 29, 1929, when the DJIA fell 12% - one of the largest one-day drops in stock market history. More than 16 million ...
  5. Black Monday

    October 19, 1987, when the Dow Jones Industrial Average (DJIA) lost almost 22% in a single day. That event marked the beginning ...
  6. Monetary Policy

    Monetary policy is the actions of a central bank, currency board or other regulatory committee that determine the size and ...
Trading Center