Investing in Silver traditionally provides a level of stability. Silver and Gold are seen as safe haven assets that traders run to when there is uncertainty in the markets. With Silver futures the scenario is a bit different.
Silver future contracts are an agreement between two parties to trade silver at some future date, at a predetermined price. The silver seller is committed to providing the agreed silver at that date at the assigned price, and the silver buyer is committed to paying for the agreed silver at that date at the assigned price.
The COMEX
In the United States, Silver futures are mainly traded on the New York Commodities Exchange (COMEX). The COMEX stipulates contracts and dates of contract expiration. The third last business day of the month is always set as the expiration date, and delivery is required at latest by the last business day of the month. Expiration dates are every two months up to 23 months, and July and December up to 60 months.
Physical Delivery of Silver Rarely Happens
One important thing to keep in mind is that in reality, buyers rarely take possession of the silver in a physical form. They normally cover-off their investment before expiration and liquidize their positions. In essence the investors are predicting price movements and taking positions to gain financial profit, which they then wipe out with an offsetting position before actual delivery would take place.
Down Payments and Margins
To trade futures both sides of the trade must place a down payment margin. An independent central clearer will take these deposits and guarantee the positions of each party for the other. The COMEX set these margins for futures traded in the USA.
There is an initial margin of $18,900 on Silver at writing (Jan 2013) and a maintenance margin of $14,000. The margin represents about 1/11th of the value of the silver being traded and so this represents a leveraged position of 11 times capital investment.
Futures are settled daily. If the spot price falls then losses are taken from the margin and it has to be replenished. For example, if silver was at $33 per ounce and the $14,000 covered 5,000 ounces then the total silver being traded would be $165,000.
If the silver price dropped 2% then there would be a loss of $3,300. This would be taken from the $14,000 maintenance fund, which would have to be brought back up to $14,000 or the investment would be automatically liquidated. Sometimes COMEX raises the maintenance margins as well, so this can be an additional risk to investors.
The Advantages of Silver Futures
The obvious advantage of Silver Futures is the ability to leverage ones position significantly. It is possible to build a large silver position with limited investment capital. There is no need to take physical delivery and to store the silver either, and there are lower transaction costs.
The Disadvantages of Silver Futures
The main challenge with silver futures is that the leveraged position can mean massive losses as well as gains. Leverage can either be a blessing or a curse. In addition, there is no silver actually being held by the investor; in the event of a financial crisis there is just a future contract to show for the investment.
With the volatility of silver investors may have to replenish their maintenance fee several times over the course of their investment. Futures are a conviction position for those with a real and thorough understanding of the silver market.