29 Questions for a Futures Broker
(Questions you should have answered, before you trade any futures contracts!)
Silver Stock Report
by Jason Hommel, February 19th, 2009
I have compiled 6 sets of answers to this article, here:
I don't trade futures contracts or options, and I
never have, and I don't recommend them for anyone.
So, clearly, I have a certain ignorance of the subject, based on a lack of direct personal experience, and that will, of course, be reflected in my questions. On the other hand, I do have my opinions about the nature of futures, what they do, and how likely they are to default, based on other research and statistics that I'd like to share with you, and ask about. I will start with some basic questions about how futures and options work.
I know one silver futures contract is for 5000 ounces of silver, which is for five 1000 ounce bars, and each bar may vary by weight up to 10%, and that the difference is settled upon delivery.
1. When one buys a silver futures contract at the NYMEX, how far out are the contracts traded, meaning, what is the maximum length of time from now that delivery can be contracted for?
2. And what is the typical length of time for most contracts? How far out is the largest and most heavily traded contract month?
3. Can you explain why the time limit on contracts exists, for example, why don't they trade twice as far into the future? Is it lack of liquidity, lack of desire of traders, or does the "time" become too expensive, or what?
4. If one buys a futures contract in silver, about 1 year out at about current prices, what kind of leverage can be purchased? What's the percentage of the value of the silver that you have to put as a down payment to buy 1 contract? In other words, what's the cost of 1 contract about 1 year out at about current prices right now?
5. I know options give one the right, but not the obligation to buy a futures contract. And thus, you can't get a margin call with options, and you can't lose more than what you pay, in case the price moves against you temporarily. What is the cost of an option on that same futures contract, about 1 year out, at current prices?
6. Do you prefer to trade options, or futures, or do you have no preference, or do you simply buy what is cheap depending on market conditions?
7. What is the typical liquidity of the silver options market? Specifically, how much money can one spend to move the silver options market more than 5-10%? What's a typical spread in case one were to buy and sell a silver options contract immediately, say, 1 month away, or 1 year out?
8. I understand there are position limits of 1500 contracts in a given month. How much money would it take, at a minimum, to buy 1500 silver options contracts, a year out, at the best prices, in your opinion?
9. What is the open interest in silver options contracts, a year out, in the most liquid contracts?
10. What is the silver options market saying about future silver prices a year from now, right now? Does the options market give any sort of prediction on price, based on how the options are priced? For example, what does the silver price need to be a year from now, in order to put a silver futures option one year out, "in the money"?
11. How are most futures contracts priced,
who prices them, and by what method? Do most traders use computers
and a black-scholes model, or do they look at charts, or is it just "the
12. What gives you confidence that there won't be a default in silver futures contracts at the NYMEX?
13. It's my understanding that the NYMEX went public a few years ago, and was recently sold to the CME. With public ownership via stock, there comes the benefit of limited liability. Thus, it seems to me that the exchange owners have now a somewhat reduced liability in the event of a default in the silver futures, thus, it seems to me that one of the protections against default has been removed. Is my reasoning off base here?
14. I'm concerned about default because the open interest is always so much higher than the silver that is in the warehouses, both registered and eligible for delivery.
As of 2-10, the open interest is 130,692 contracts
for 5000 oz. each.
Right now, the silver warehouse stocks, total,
registered and eligible, for all 4 warehouses, is 124.7 million
That seems to be quite an imbalance, so what is the guarantee that the shorts can deliver silver to the longs?
15. The CPM Group produces an annual
yearbook of statistics on silver. Are you familiar with this group,
and if so, what do you think of the quality of their research?
16. There is another major market in silver, besides the NYMEX, and I'm speaking of the LBMA, the London Bullion Market Association, which is a group of very large bullion banks that all act as market makers for bullion orders for their own clients. http://www.lbma.org.uk/members_list.html
In the 2008 CPM Group yearbook, on page 16, they list the Estimated Silver Inventories in London and Zurich at about 75 million ounces for 2006. That seems a rather small amount, what do you think?
17. The CPM group also lists that the LBMA annual trading volumes in silver are 30 billion ounces. That seems excessive in light of how little silver the CPM Group lists in the estimated silver inventories. Do you think such trading volumes are excessive, if they are based on so little silver, as it seems that the entire stock of silver is traded more than that daily! 30,000 million ounces, divided by 250 trading days, would require an average of 120 million ounces of silver traded daily, on average, which is far more than the 75 million ounces estimated that they have. Do you find that much trading to be excessive, or do you think it's evidence that they are trading silver that they do not have?
18. Morgan Stanley, who is not a LBMA market making member, but who also trades silver for clients and offers unallocated silver accounts, recently admitted that they practice fractional reserve silver banking, as follows:
Ted Butler writes:
"In fact, in the court documents summarizing the
proposed settlement, one of Morgan Stanley's defenses was that they were
not doing anything unusual by charging storage on metal that didn't exist,
as this is a widespread industry practice."
Does that concern you, and do you have an opinion or comment on that?
19. I would like to discuss some of the overall market silver statistics. The CPM Group and Silver Institute have somewhat similar numbers, but they both say that about 600 million ounces of silver is mined each year, and about 900 million ounces total supply, with the difference being recycling, government selling, and/or investor selling. They both say that investor buying is very small, about 40-60 million ounces per year, and this is actually a new trend, ending investor selling. This means that about 5-10% of the silver market is investor buying. At $15/oz., that's just under $1 billion worth of investor demand, annually.
Do you see these supply and demand factors as more bullish than for gold, since there is less room for new investor demand?
20. Are you aware of the reports of silver
shortages for all retail forms of silver, from 1 ounce rounds, to 100
ounce bars, to Silver Eagles and Maples? For example, the U.S. Mint,
although producing nearly twice as many Silver Eagles this year than last
year, is trying to illegally ration them?
21. Is there any indication that 1000 ounce COMEX bars are in short supply, and if that were to happen, how would we know?
22. It seems to me that the world has had a shortage of silver, and an excess of paper money, ever since the U.S. left off using silver in coinage, in 1964. But particularly, today, the amount of paper money that exists seems more excessive than ever, with M3 at over $14 trillion, and silver seems to be in a particularly short supply.
Are you concerned about these things as well?
23. It seems to me that in both the LBMA, and the NYMEX, that most silver sold is sold by institutions or traders who are "naked short", meaning that the physical silver to back the positions is not held by them. Do you think that is a fair assumption, based on the statistics I've covered above?
24. The Silver ETF claims to have over 253
million ounces of silver backing it.
During the time of it's inception, silver at COMEX remained essentially unchanged, and the silver price remained unchanged. Many people are wondering, where this silver came from, how could so much be bought without moving up the price, and if it really exists.
JP Morgan is the ETF custodian, and JP Morgan is also rumored to be the largest silver short at the COMEX holding down the price. That seems like a conflict of interest, to say the least. JP Morgan also holds about 7 times the gross national product of the USA in derivatives.
So, given that, would you trust the ETF, or futures contracts more?
25. What do you think of private companies that offer people "leveraged silver" programs? It seems to me that they are mostly scammers, since they offer less leverage, on worse terms, than you can get in the futures market. Is that your opinion as well?
26. If someone buys a silver futures contract through your brokerage, could you help them take delivery?
27. If someone expected silver prices to rise a minimum of 25% annually from today, with the understanding that there could be times lasting 1.5 years where no gains would take place, based on those assumptions, suppose you had a client who was interested in buying silver futures contracts or options with about $100,000 that they could afford to lose, is there a particular strategy that you could recommend?
28. What do you think of precious metals dealers who sell physical silver but cannot deliver for up to, or exceeding, 60 days. Do you feel that is reasonable or not, or is it like a futures contract?
29. I would like to thank you so much for your time and help in answering these questions for me and my readers. Is there anything you would like to add that you feel I did not cover, or that you would like to say?
Again, thank you so much for taking the time. I and my readers will really appreciate it.