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COMEX 101:

All About the Gold and Silver Futures Market


Although this page usually refers specifically to silver, the same applies to gold with a few minor differences (e.g. the contract size of 100 vs 5,000 oz, and the costs involved).

Silver futures are just an agreement between two parties, where one agrees to buy a specific amount of silver from the other at a set time in the future. In the United States, this is normally done through an organization called COMEX.


What is a Short Sale?

A short sale is when someone agrees to sell silver in the future (which they usually do not have). This is perfectly legal, and necessary for the futures market to work. Without someone agreeing to sell in the future (the short), nobody could agree to buy in the future (the long). There must be one short seller for every long. The short seller is hoping that the price of silver will go down, and that when the contract expires, they will simply be paid the difference in the price of silver if it has gone down. There is a chance that they may need to deliver the physical silver (regardless of how the price moves), in which case they would need to buy it.


How Does the Buying Process Work (Going Long)?

Let's say it is January 1, 2010. You decide that you want to buy some silver. You decide to 'go long' 1 contract of June, 2010 silver at $20/ounce. This means that you agree to buy 5,000 ounces of silver (the amount per contract) in June, 2010 (although if you do not want to take delivery, you can sell the contract before June, 2010) .

In order for you to make this agreement, someone else needs to 'go short' 1 contract of June, 2010 silver at $20/ounce, in which they agree to sell 5,000 ounces of silver at $20 in June. If they want, they can deliver the silver to the warehouse and get their $20/ounce, or they can buy a long position to offset their short position.


Where Does the Silver Come From (Taking Delivery)?

The vast majority of futures contracts end up being settled in cash, where no silver changes hands. But, if you want the physical silver, you can get it -- after all, that is the whole point of the futures market. When your contract is about to expire, here are the possible outcomes:

  1. You decide that you want the silver, and you want to keep it in the COMEX warehouse. You wait (called 'standing for delivery'), and by the end of June, 2010 the short will have given the Clearing House a Notice of Intention to Deliver. The Clearing House will then send an Assignment Notification to the seller and to you, which lets you know who the seller is, and a list of the serial numbers of the bars you will receive. You will also receive an invoice. The short will deliver to a COMEX warehouse the 5,000 ounces of silver (or turn in a warehouse receipt, if they have one -- it appears that they can buy them from bullion banks that have silver in the Registered category). You are then given the warehouse receipt (or your dealer can hold it for you), at which point you own the silver.
  2. You decide that you want to take delivery. The same as situation #1 happens, except you then immediately request delivery and turn in your warehouse receipt. You get your silver.
  3. You decide that you do not want the silver, you want to take the profit or loss. In this case, you sell your contract at the current price (before the beginning of June, 2010 -- or else you may have to take delivery). If the price is now $21, you make $5,000 profit; if it is $19, you have a $5,000 loss .
  4. You decide that you do not want the silver, but you want to keep a futures position. In this case, you roll over the contract, by selling your current contract and buying one for a future month.

What is in the Warehouses?

COMEX has several warehouses for metals (see the lists for silver and gold). They contain lots of silver. They had 152.003 million ounces (as of 17 Jan 2013), worth about million. This is split into two categories: Eligible and Registered.

Eligible silver is silver that is in a COMEX vault and has been determined to meet the COMEX requirements (e.g. minimum fineness and weight, acceptable refiner). Often this is silver that has been purchased by a long (paid in full, not part of a COMEX contract) at some point in the past (that they are currently paying storage fees for). The silver is eligible for delivery at any point that the owner wants. It has been assigned to the owner, who has the serial numbers of their bars. Eventually, it will either be delivered to the owner, or become registered silver. It is the same as silver in any other vault, except that the silver is within the COMEX system (known to meet COMEX requirements).

Registered silver is silver that is sitting in the COMEX warehouse, and can be used to settle a contract. The warehouse has issued a depository receipt (warrant). Warrants are issued in the name of an Exchange Clearing Member (corporations that handle trades, typically for their customers), not individual traders. When a short needs to settle their contract, the silver they provide the long must be registered. The short can buy it from a bullion bank, convert eligible silver they have, or use silver they they had previously stopped (from a long contract). As of 17 Jan 2013, there were 37.976 million ounces of registered silver (available), worth about million and 114.027 million ounces of eligible silver (customer owned) in the COMEX warehouses, worth about


Position Limits

COMEX has position limits, which are the maximum number of contracts that you can have open at one time. As of this writing (June, 2010), anyone with 150 silver (or gold) contracts needs to report to COMEX their positions. The limit is 1,500 contracts in the current (spot) month for silver (3,000 contracts for gold), with 6,000 silver (or gold) contracts in all months combined. The position limits can be found at the COMEX website.

For silver, the 1,500 contracts controls 7,500,000 ounces of silver, worth about million. For gold, the 3,000 contracts controls 300,000 ounces of gold, worth about million.


Costs

There are various costs involved in purchasing silver (or gold) through the futures markets. Here are the ones we are aware of:


Margins

When you buy a long position or sell a short position, it is done on margin. So if you buy a long contract for 5,000 ounces of silver for June, 2010 at $20, the total value of the silver is $100,000. However, you would only be required to put down a small amount (perhaps $5,000). If the price of silver goes up, the money is deposited into your account. If the price of silver goes down, money is removed from your account, and when it gets below a certain amount, you are required to immediately come up with the more money (or else your position is sold).

Let's again assume that silver is $20/ounce, and you have $100,000 to spend. If you wanted to put all that money into physical silver (as opposed to futures), you could go out to a bullion store and spend $100,000 and get it today. Or, you could put down a small amount ($5,000 in the example above), and then pay the other $95,000 when you received the delivery notice.

If you are looking to play the market, and think the price of silver is going to go up, you could instead buy 20 long contracts (100,000 ounces of silver worth $2M) for that $100,000. If silver goes up $1, you would make $100,000, and double your money! If silver goes down $1, though, it wipes out your entire investment, and you would be required to put up another $100,000 to keep the position (or else it would be liquidated, or sold).

This leverage can obviously be very lucrative, or very dangerous (if you are not careful).


Offsetting

You may have noticed that buyers are required to take delivery of metal, and sellers are required to make delivery of the metal -- unless they offset their positions. So how does that work?

Let's say that there are currently no June, 2010 contracts. You are the first to buy one, and you go long 1 contract. For that to happen, someone else goes short 1 contract (promising to deliver the silver in June, 2010). The short is required to either deliver, or buy an offsetting position (in this case, 1 long contract). Since there is only 1 long contract they can buy (yours), if they buy it, they would have to deliver to themselves -- so the exchange doesn't require them to deliver. If you were not willing to sell your long contract, the short would have to provide you with the metal (but there are market makers that help ensure that the short can buy an offsetting long contract).

Or, let's say that you ("Long A") buy 1 long contract for June, 2010. Someone ("Short A") sells short 1 contract, in order for you to buy. Then, someone else ("Long B") goes long 1 contract (which requires another person ("Short B") to go short 1 contract). At this point, there are 2 people with a long position, and 2 people with a short position. If Short A does not want to deliver, he can buy the long contract from Long B. Now there is 1 person with a long position (you, Long A) and one person with a short position (Short B). When it comes time to deliver, Short B will provide the silver to you. Short A is now also Long B, so as before, the exchange doesn't require him to deliver to himself.

That's how offsetting works. Essentially, if you have both long and short positions, any extras get cancelled out. So if you have 1,000 long positions and 100 short positions, you end up with 900 long positions. Or, if you have 1,000 short positions and 100 long positions, you end up with 900 short positions.


Delivery Notices

A short seller is required to either close out his position by buying an offsetting long position, or deliver the silver. This is done by issuing a delivery notice ("Notice of Intention to Deliver"). COMEX then decides which long will be assigned the delivery (whoever bought their long position first), and sends an Assignment Notification (to the long and short), and the long must then accept and pay for a warehouse receipt (which they can pay to keep stored at the warehouse, or pay to have physical delivery).

COMEX has reports on how many delivery notices were generated each day, month, and year. The reports show which firms had clients issue the notices (shorts delivering the silver), and which stopped the notices (had clients receiving the silver).


Is a Long Guaranteed to Receive Silver?

Yes. Some people are confused about this, as COMEX doesn't make it clear to people who aren't active in futures. Someone active in futures knows that a futures contract is exactly that -- a contract. It is a contract to buy or sell a specific amount of metal at a specific month in the future at a specific price.

The confusion arises because the short gets to decide when they deliver the silver -- either at the beginning of the month, the middle, or the end. A long cannot initiate the process. However, the short must initiate the process at some point during the month -- they are required to do so by their contract.

Another point that confuses novices is when they read that when a short gives a Delivery Notice, COMEX will assign it to the long that got their position earliest. This makes it sound like some longs won't be assigned delivery. But, for every long there is a short, so it just means that earlier purchasers of long positions will get delivery earlier in the month; those that got their positions more recently may have to wait closer to the end of the month. But all longs will be assigned a delivery, unless they buy an offsetting short position.

The final piece of the puzzle is what happens if the short does not deliver the silver? In this case, the Clearing Member (the firm that the short's contract went through) is required to deliver the silver (per 7B02). If they cannot, COMEX rules state that COMEX will not be liable for more than the value of the metal at the time of default (per 7B14), and only if they are notified within 60 minutes. However, we are not aware of instances that this has happened, and the person to receive the silver was not fairly compensated. If there were such a default, it would seriously damage the reputation of the COMEX, and could possibly disrupt the silver market, so it would be avoided at all costs. And, a long in theory would be able to sue the short and the Clearing Member (and probably COMEX, although they would be better protected).


Can you be Forced to Take or Make Delivery?

Yes and no. Specifically, futures contracts are exactly that -- contracts to buy or sell something in the future. So if you buy a long contract, you are obligated to take delivery; if you sell a short contract, you are obligated to deliver the silver. But, if you do not want to, you can offset your contract (e.g. sell short if you have a long contract), which gets rid of your obligation.


The Delivery Month

The Delivery Month is the month in which the short is required to deliver the silver. However, there are a number of dates involved:

Why Farther Months Cost More

If you look at the futures price of silver, you'll notice that in most cases, the longer it is until delivery, the more the contract costs. For example, as of this writing, June 2010 silver is $18.18, but June 2014 silver is $18.84. This is a situation referred to as contango, and is normal.

At first, people might assume that is because people expect the price of silver to rise. However, the real reason for that is because the short seller (if they are not naked) has to pay warehouse storage fees, and loses interest that he could make on his money if he sold the silver today. So the short is going to want more money the farther out the contract is. And the long is willing to pay that, since they avoid paying storage fees and make interest on their money.

There are rare exceptions to this rule, where something called backwardation occurs. Backwardation means that the closer months cost more than the farther months. This can happen if there is concern that silver may not be easily available in the future, and that you are more likely to get your silver if you choose a closer month. This is a very bullish situation, and would likely lead to higher prices.


Report: Commitment of Traders

The Commitment of Traders is a report published by the CFTC every week. It lists how many contracts are held by the 4 largest traders combined and how many are held by the 8 largest traders combined. It also reports how many contracts are held by various categories of traders (currently, "Producer/Merchant/Processor/User", "Swap Dealers", "Managed Money", "Other Reportables" and "Nonreportable Positions" (traders with less than 150 contracts)).

Most people will not find much use for this data. However, it can be used to help determine if there is market manipulation. For example, if the 4 largest traders have a very high percentage of the open interest, it is more likely that they could influence the price.


Report: Bank Participation Report

The Bank Participation Report is a report published by the CFTC every month. It lists how many banks have short or long positions in each futures market, and what percentage of the open interest is held by all the banks combined.

Most people will not find much use for this data. However, it can be used to help determine if banks are able to influence the price of silver.


Options

Options give you the right (but not obligation) to buy or sell futures contracts, at a set price at a set time in the future. A call option lets you buy silver, a put option lets you sell it.

For example, if silver is $20/ounce and you think it will go to $25/ounce by December, you could buy $22 December call options. If silver does go to $25/ounce by December, you would be able to sell the options for about $3/ounce profit. Or, you could pay the $22/ounce and convert them to futures contracts (which you could then have delivered or stored in a warehouse, if you wished).


Terms

Backwardation
- The situation where silver will cost more for closer delivery months. This can occur if there is a concern that silver may not be delivered in the future. See also Backwardation.
Bank Participation Report
- A report by the CFTC that shows how many banks hold futures positions, and how many contracts are held in total by all the banks.
CFTC
- The Commodities Futures Trading Commission, the organization in the United States that is responsible for overseeing the futures markets.
Clearing House
- The organization that is in charge of clearing futures contracts (COMEX) (see COMEX site).
Clearing Member
- A firm that is approved by COMEX for clearing transactions (see COMEX site).
Contango
- The normal situation where the longer it will be until the delivery month, the more the silver will cost (to account for storage fees). See also Backwardation.
Contract
- A set amount of silver (5,000oz) or gold (100oz) to be bought or sold on a specific date. So if you go long 10 contracts of silver, you will be buying 50,000 ounces of silver.
COT
- The Commitment of Traders report. This is issued by the CFTC, and lists number of contracts held by largest 4 and 8 traders, as well as a breakdown of contracts by the type of trader.
Delivery Day
- The day that the long receives the warehouse receipt. It can be any business day in the delivery month. For more details, see NYMEX Rulebook 7A06-E(1). The warehouse receipt is received electronically, normally at 7:30AM CST (8:30AM EST).
Delivery Notice
- See Notice of Intention to Deliver.
Eligible
- When referring to silver in a warehouse, it means that the silver is eligible for delivery (to a long that has a warehouse receipt, and is paying storage fees). See also Registered.
Long
- Agreeing to buy a specific amount of silver in the future at a set price in a set month. See also Short.
Naked Short
- Someone who agrees to sell silver in the future, but does not have any silver to back up the contract. This is legal (the person just needs to buy real silver before or at delivery, or buy an offsetting long position before the contract is up).
Notice Day
- The day that an Assignment Notification is issued by the Clearing House (COMEX) to the buyer and seller. This is the day that the seller finds out who the buyer is, and the buyer finds out who the seller is, and the serial numbers of the bars that they will receive. See 7A06(C).
Notice of Intention to Deliver
- A notice from the short that states that he will be delivering the silver, and which bars will be delivered. Someone who is short silver must file a 'Notice of Intention to Deliver' with the COMEX, unless they instead buy an offsetting long position, so they do not have to deliver the silver. See 7A06(B).
Offsetting Position
- The opposite of the position that you have. If you have a short contract, you can buy a long contract (for the same month and price), which is called the offsetting position. One you have done so, you have no obligation to deliver the silver. If you have a long contract, you can sell a short contract (for the same month and price), and then you do not have to take delivery.
Open Interest
- The total number of contracts for a given commodity and monthly. So if for June 2010 silver there are 13,580 longs (in which case there are also 13,580 shorts), you would say the open interest for June, 2010 silver is 13,580.
Registered
- When referring to silver in a warehouse, it means that the silver is owned by COMEX and/or bullion banks, and can be bought by shorts for delivery. See also Eligible.
Short
- Agreeing to sell a specific amount of silver in the future at a set price in a set month. See also Long.
Standing for Delivery
- Waiting until your long contract expires, to get your silver.
Stop
- A term indicating that a delivery notice was given to the buyer. In delivery reports, COMEX shows both how many Delivery Notices were 'issued' (the short notifying that they would be delivered) and 'stopped' (the long receiving the delivery notice).
Warehouse Receipt
- A 'receipt' that entitles you to a specific amount of silver. It lists the specific bars that you own, including the brand and serial numbers.
Warrant
- The method used to give you ownership of silver in a warehouse, per Article 7 of the Uniform Commercial Code. It is the same as a warehouse receipt.

Other Information (was: Remaining Questions)



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