After gold, silver is the most invested precious metal commodity. For centuries, silver has been used as currency, for jewelry, and as a long term investment option. Various silver-based instruments are available today for trading and investment. These include silver futures, silver options, silver ETFs, or OTC products like mutual funds based on silver. This article discusses silver futures trading—how it works, how it is typically used by investors, and what you need to know before trading.

The Basics

To understand the basics of silver futures trading, let’s begin with an example of a manufacturer of silver medals who has won the contract to provide silver medals for an upcoming sports event. The manufacturer will need 1,000 ounces of silver in six months to manufacture the required medals in time. He checks silver prices and sees that silver is trading today at $10 per ounce. The manufacturer may not be able to purchase the silver today because he doesn’t have the money, he has problems with secure storage or other reasons. Naturally, he is worried about the possible rise in silver prices in the next six months. He wants to protect against any future price rise and wants to lock the purchase price to around $10. The manufacturer can enter into a silver futures contract to solve some of his problems. The contract could be set to expire in six months and at that time guarantee the manufacturer the right to buy silver at $10.1 per ounce. Buying (taking the long position on) a futures contract allows him to lock-in the future price.

On the other hand, an owner of a silver mine expects 1,000 ounces of silver to be produced from her mine in six months. She is worried about the price of silver declining (to below $10 an ounce). The silver mine owner can benefit by selling (taking a short position on) the above-mentioned silver futures contract available today at $10.1. It guarantees that she will have the ability to sell her silver at the set price.

Assume that both these participants enter into a silver futures contract with each other at a fixed price of $10.1 per ounce. At the time of expiry of the contract six months later, the following can occur depending upon the spot price (current market price or CMP) of silver. We will walk through several possible scenarios. 

In all the above cases, both the buyer/seller achieves buying/selling silver at their desired price levels.

This is a typical example of hedging—achieving price protection and hence managing the risk using silver futures contracts. Most futures trading is intended for hedging purposes. Additionally, speculation and arbitrage are the other two trading activities which keep the silver futures trading liquid. Speculators take time-bound long/short positions in silver futures to benefit from expected price movements, while arbitrageurs attempt to capitalize on small price differentials that exist in the markets for the short term.

Real World Silver Futures Trading

Although the above example provides a good demo to silver futures trading and hedging usage, in the real world, trading works a bit differently. Silver futures contracts are available for trading on multiple exchanges ac ross the globe 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 futures 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 (2,500 troy ounces)
  • micro (1,000 troy ounces)

A price quote of $15.7 for a full silver contract (worth 5,000 troy ounces) will be of total contract value of $15.7 x 5,000 = $78,500.

Futures trading is available on leverage (i.e., it allows a trader to take a position which is multiple times the amount of the available capital). A full silver futures contract requires a fixed price margin amount of $12,375. It means that one needs to maintain a margin of only $12,375 (instead of the actual cost of $78,500 in the above example) to take one position in a full silver futures contract.

Since the full futures contract margin amount of $12,375 may still be higher than some traders are comfortable with, the E-mini contracts and micro contracts are available at lower margins in equivalent proportions. The E-mini contract (half the size of the full contract) requires a margin of $6,187.50 and the micro contract (one-fifth the size of a full contract) requires a margin of $2,475.  

Each contract is backed by physical refined silver (bars) which is assayed for 0.9999 fineness and stamped and serialized by an exchange-listed and approved refiner. 

Settlement Process for Silver Futures

Most traders (especially short term traders) usually aren’t concerned about delivery mechanisms. They square off their long/short positions in silver futures in time prior to expiry and benefit by cash settlement.

The ones who hold their positions to expiry will either receive or deliver (based on if 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 positions, respectively. One warrant entitles the holder the ownership of equivalent bars of silver in the designated depositories.

In the case of E-mini (2,500-ounce) and micro (1,000-ounce) contracts, the trader either receives or deposits Accumulated Certificate of Exchange (ACE), which represents 50 percent and 20 percent ownership respectively, of a standard full-size silver warrant. The holder may accumulate ACE’s (two for E-mini or five for micro) to get a 5,000-ounce COMEX silver warrant.

Role of the Exchange in Silver Futures Trading

Forward trading in silver has been in existence for centuries. In its simplest form, it is just two individuals agreeing on a future price of silver and promising to settle the trade on a set expiry date. However, forward trading is not standard. It is therefore full of counterparty default risk. (Related: What Is the Difference Between Forward and Futures Contracts?)

Dealing in silver futures through an exchange provides the following:

  • Standardization for trading products (like the size designations of full, E-mini or micro silver contracts)
  • A secure and regulated marketplace for the buyer and seller to interact
  • Protection from a counterparty risk
  • An efficient price discovery mechanism
  • Future date listing for 60 months forward dates, which enables the establishment of a forward price curve and hence efficient price discovery
  • Speculation and arbitrage opportunities that require no mandatory holding of physical silver by the trader, yet offer the opportunity to benefit from price differentials
  • Taking short positions, both for hedging and trading purposes
  • Sufficiently long hours for trading (up to 22 hours for silver futures), giving ample opportunities to trade

Market Participants in the Silver Futures Market

Silver has been an established precious metal in dual streams:

   •   It is a precious metal for investment

   •   It has industrial and commercial uses in many products

This makes silver a commodity of high interest for a variety of market participants who actively trade silver futures for hedging or price protection. The major players in the silver futures market include:

   •  The mining industry

   •   Refineries

   •   Electrical and electronics companies

   •   Photography companies

   •   Jewelry businesses

   •  The automobile industry

   •   Solar energy equipment manufacturers

The above players mainly trade silver futures for hedging purpose aimed to achieve price protection and risk management. 

Another source of the major players in silver futures markets is the financial industry. These players may also be in it for the speculation and arbitrage opportunities and include:

   •   Banks

   •   Hedge funds and mutual funds

   •   Proprietary trading firms

   •   Market makers and individual traders

Factors Affecting Silver Futures Prices

The last few years have seen very high levels of volatility in silver prices, possibly pushing silver beyond the generally perceived limits for safe asset classes. This makes silver a highly volatile commodity to trade.

Around 1990, the industrial demand for silver was around 39 percent of total demand. The remainder was for investment purposes. At present, industrial demand consists of over half of the total demand. This increased industrial demand is the primary factor for increased volatility in silver prices. A recession or slowdown in industrial demand would lower silver prices. 

On the other hand, many situations could increase the demand for silver and lead to higher prices. An expansion of the electronics and automobile industry would lead to a higher demand for silver. Increasing oil prices could also increase the demand for silver by forcing the use of alternative energy, such as solar. Solar energy equipment uses silver. To try and predict future silver prices, investors should consider the following:

On the supply side, study estimated and actual mine production, especially in major silver producing countries like Mexico, China, and Peru.

On the demand side, follow both the industrial demand and investment demand for silver.

In macroeconomics, take into account the overall economy at a national or global level. Study the relative performance of alternative investment streams including gold, the stock market, and oil among others.

The Bottom Line

Silver has been a highly volatile commodity in recent years, making it a high-risk asset. Apart from factors affecting physical silver prices, silver futures trading is also impacted by contango and backwardation effects which are specific to futures trading. In the real world, futures trading also requires mark-to-market fulfillment daily. Traders should be aware of this and keep sufficient capital allocated for it. Although small-sized E-mini and micro silver futures contracts are available with leverage, the trading capital requirements can still be higher for retail traders. Trading silver futures is advisable only for experienced traders who have sufficient knowledge in futures trading.