The precious metals markets, namely gold and silver, offer traders the allure of large profits. However, high margins and unpredictable volatility are often too much for the average retail trader to handle. Likewise, using unleveraged alternatives, such as the ETF, GLD, forces traders to face other obstacles, including inefficient price movement and hidden costs. There are some alternative lower risk products available to those interested in dipping their toe into metals trading, but there are some things you will need to know.
Most people are surprised to learn that the liquidity of the gold and silver markets, whether you are referring to the cash market, the futures market, or the ETF market, is questionable at times. Although both are deep, relative to most commodities, the contracts traded in gold and silver are a mere fraction of those traded in more mainstream markets, such as stock indices, US Treasuries, and even crude oil. Because of this, it is imperative that traders consider volume, and other measures of liquidity, when determining trading strategies.
Full-Sized Metals Futures
The traditional, full-sized, metals-futures contracts are highly leveraged and represent a substantial amount of the underlying asset. Due to high margin requirements and wild account swings, most retail traders aren’t financially, or mentally, equipped to trade these products. Mini and micro metals futures contracts might be a wiser choice for most small speculators.
Gold
A full-sized gold futures contract represents 100 ounces of gold. A trader can buy or sell this contract with a margin deposit of a mere $4,400. Consequently, the trade will make or lose money based on the value of 100 ounces of gold, or $116,500 (if gold is priced at $1,165). On most days, gold prices fluctuate within a $5 to $10 range (equivalent to $500 to $1,000 per futures contract). However, it isn’t necessarily uncommon for gold to move $50 in a single trading session. When this happens, a trader stands to make or lose $5,000 per contract. Placing $5,000 on a one-lot trade might be too steep for many traders.
Silver
The original silver-futures contract is written against 5,000 ounces of the underlying asset. At the time of this writing, the margin requirement was $6,050 and silver was priced at $15.65 per ounce. Thus, for a little over $6,000, a trader can hold a contract worth about $78,250 in silver. Similar to gold, silver shows little mercy to those caught on the wrong side of a trade. Silver typically moves between 10 to 30 cents a day, or $500 to $1,500, but it has been known to make moves of $2.00 to $3.00 in a single day. A trader long or short silver on such a day would have enjoyed a windfall of $10,000 to $15,000, or suffered an equivalent loss.
The most obvious way to get your foot in the door with limited capital, or risk tolerance, is to trade precious metals using the option market. Options are incredibly versatile and, therefore, cannot be lumped into a single risk/reward profile, but I think it is fair to say that most option strategies offer lower volatility and, possibly, lower risk than buying or selling metals futures outright. With that said, option sellers face the similarly unlimited risk that futures traders accept. Option buyers, on the other hand, enjoy the comfort of limited risk, but they are subject to lower odds of success. However, despite the advantages option trading generally provides, it is not viable in all commodity markets; arguably, it isn’t advised in silver.
Gold Options
Gold options are certainly liquid enough, but they can be highly treacherous. Those selling options in hopes of collecting large premiums as an income strategy, can quickly find themselves in a compromising situation. It isn’t uncommon for gold options to double in value in a single trading session, regardless of whether or not the market ever threatens your strike price. For example, a trader that sells a $1,050 gold put for $500 is betting that the price of gold will be above $1,050 at expiration. If so, the trader keeps the $500 minus transaction costs. In the meantime, the option value could easily increase to $1,000 on a volatile decline (causing a paper loss of $500), regardless of whether the price of gold ever falls below $1,050.
Conversely, option buyers can see the value of their long option cut in half, should they place a bet in the wrong direction, or at the wrong time. Accordingly, although gold options offer traders debatably less volatile trading vehicles than outright futures, they can still be rather expensive if your speculation is off. Further, gold options tend to have less room for error than other commodity markets might.
Silver Options
Silver options are incredibly difficult to trade due to intrusively wide bid/ask spreads (the difference between the buying price of the option and the selling price of the option). Beginning traders often overlook the vast illiquid nature of the silver option market because of all the fanfare silver receives in the media. However, the COMEX division of the Chicago Mercantile Exchange opts to list strike prices in this market every quarter. Consequently, the liquidity is spread between so many instruments it creates a thin environment. In my opinion, traders are better off using silver options sparingly, or maybe even avoiding them altogether.
Because of the “hidden” transaction costs, a trader can immediately be in the hole to the tune of $100 to $200 upon trade entry. As you can imagine, this make it extremely difficult for long-option traders to turn a profit. Not only does the trader have to be accurate on direction and timing, but the price move must be substantial. Silver option sellers, on the other hand, put themselves into an environment of relatively enhanced danger. Liquidity issues can cause option values to explode quickly, and can sometimes create a scenario in which exiting the trade at a reasonable price is nearly impossible.
Mini and Micro Futures
Perhaps a better means of entering the metals markets is through the mini and micro futures contracts. They don’t offer the profit potential full-sized metals futures and options might, but they do grant small speculators lasting power and room for inaccuracy. Their low margins and relatively tamer risk also give the average trader some peace of mind.
Mini Gold (YG)
The mini-gold futures contract listed on the Intercontinental Exchange(ICE) is 1/3 the size of the traditional futures contract and carries a margin requirement of about $1,650. Traders in this product are exposed to 1/3 the volatility of holding a full-sized contract. Accordingly, a typical day might see a profit or loss of $166 to $333 per contract. Although there is no limit to chaos in the precious metals markets, daily price swings on a mini can easily extend into the $1,500 to $2,000 on a wide ranging day. Nonetheless, this is far more reasonable than the $5,000 (+) that comes with holding a full-sized contract.
Mini Silver (YI)
The ICE exchange lists its mini silver futures with a contract size of 1,000 ounces. This is 1/5 the size of a full-sized contract. In my opinion, this is the best option for most retail futures traders because of its small size, low margin ($1,375), and reasonable liquidity.
miNY Gold (QO)
The COMEX version of mini (miNY) is bigger than the ICE version, but it has considerably less liquidity than the ICE version and is moderately more risky due to a bigger contract size. This contract represents 50 ounces of gold, or half the original full-sized contract, to make each $1 in gold-price movement worth $5 to a trader.
miNYSilver (QI)
The COMEX version of miNY silver is half the size of the original; therefore, this contract exposes a trader to the price swings of 2,500 ounces of silver. Despite being labeled as a “mini,” this contract has the ability to post big moves. For example, a 50 cent move in silver is commonplace and would deliver a profit or loss of $1,250 per contract. On an extreme day, traders might experience swings of $5,000 per “mini” contract. Additionally, this particular mini contract lacks ample trading volume for comfortable speculation.
e-Micro Gold
The CME’s COMEX division e-micro gold is one of my favorite products for small speculators. It offers relatively attractive liquidity and a contract small enough to allow for dollar cost averaging and long-term speculation. With a margin requirement of just $440 and a typical daily fluctuation in profit and loss of $50 to $100, traders can afford to ride out the ebbs and flows, which is needed for multi-month speculation.
Conclusion
There are several ways for traders to gain exposure to price fluctuations in precious metals, but opting for the mini silver-futures contract listed on the ICE exchange or, even better, the e-micro gold-futures contract listed on the COMEX division of the CME, are likely the best “options” for small speculators. Nevertheless, each trader has a different risk profile, personality, time frame, and capital coffer.
Hopefully, this discussion helps guide traders to the products that best fit their circumstances. Don’t make the mistake of ignoring alternative means to precious metals speculation. Blindly jumping into a full-sized silver or gold futures contract could turn out to be a painful lesson.
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*There is substantial risk in trading options and futures. It is not suitable for everyone.
For more information on trading from Carley Garner, click here.
