29 Questions for a Futures Broker - Answers(Answers 2)Silver Stock Reportby Jason Hommel, March 15th, 200929 Questions for A Futures Broker These are my interview questions for any Futures Broker that I would like to publish in this Silver Stock Report which goes out to 80,000 emails. If any Futures Broker responds to my questions below, I would like to share them with my readers, and direct some business their way. If more than one Futures Broker will respond, I will publish the best answers, and perhaps list several Brokers as a reference. 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? Futures Broker: Right now you can go all the way out until the Dec 2013 contract 2. And what is the typical length of time for most contracts? How far out is the largest and most heavily traded contract month? Futures Broker: Right now the most heavily traded contract is the May 2009 contract with an open interest of 36005 contracts as of today 2/24/09. You can be in the contract until the last day of the prior contract month(i.e. April 30 for the May contract) and you must trade out of the contract before the first notice day or else you may get delivered upon if you’re long the contract. 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? Futures Broker: There a definite lack of liquidity the further out you go. I have some clients that are in the Dec 2012 contract right now and I remember the bid/ask spread to get in was pretty wide as compared to the front month contract. 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? Futures Broker: There are two contract sizes that may be traded in silver right now. There is 5000oz contract and a what’s called a “mini” contract that is 1000oz of leverage. The margin right now for the 5000oz contract is $8100 and the margin for the mini contract is one fifth the size of the big contract or $1620. The Exchange can change these margin requirements at any time for any reason. Usually they are set by the current volitilty of the commodity. 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? Futures Broker: each strike price has a different price, but I will give you an example. The Dec 2009 $20 silver call is trading at 1.12 right now. You multiply this price by the contract leverage amount(5000oz). So the premium of the this option is roughly $5600. 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? Futures Broker: I like to trade both the options and the futures for my clients. With silver, you want to have the patience to buy the big dips that occur every so often. Most of the time you are rewarded with this strategy lately, but there are times recently when this strategy would have lost a lot of money. 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? Futures Broker: Even trading the near month most liquid options, there can be large spreads to get in and out. For example, let’s say you bought a July 2009 $20 call for .50 points($2500). If you wanted to turn around and sell that option ASAP, you would probably only be able to get .48 or .47 cents. That’s equals $100 to $150 in price slippage per contract. The silver options are also still only traded in the pit at The COMEX Exchange. They are not traded electronically yet. 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? Futures Broker: Well it would depend what strike price you wanted to buy. I just checked and the Dec 2009 $50 silver calls are trading at roughly $1200 apiece according to today’s settlement prices. So $1200 x 1500 contracts would equal an investment of about $1.8 million dollars not including thecommission cost. 9. What is the open interest in silver options contracts, a year out, in the most liquid contracts? Futures Broker: The Dec 2009 option with most open interest right now is the $26 call with 2590 contracts open. The same month at $20 call has 2400 contracts open. 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"? Futures Broker: If you buy the Dec 2009 $20 silver calls, then the price would need to be above $20 in that Dec contract for the options to be in the money. Now, just because the options are in the money, doesn’t mean you would be profitable on the options. It would depend on how fast the price of the underlying futures contract went up after you bought the options. Using that Dec 2009 $20 call again as an example….You can buy them for around 112 points right now or $5600. You would need the price of silver to be over $21.25 at option expiration to break even on your trade. 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 market"? Futures Broker: the current silver contracts are traded both electronically and via “open outcry” in the pit at COMEX. Each investor uses different ways of analyzing the market. 12. What gives you confidence that there won't be a default in silver futures contracts at the NYMEX? Futures Broker: There’s never been a default on any Commodity Exchange to my knowledge, but I don’t have the confidence that they’re couldn’t ever be a default. If there were a default, I guess they would try to cash settle the contracts, but then again, what would that “cash” actually be worth if there were a default. You ask good questions. 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? Futures Broker: I think you’re reasoning is sound here. Let’s face it, we know the gov will do whatever it takes lately to paper over problems with our financial system. 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 ounces. That seems to be quite an imbalance, so what is the guarantee that the shorts can deliver silver to the longs? Futures Broker: I think you’ve answered your own question. There is no guarantee. I don’t think the shorts can guarantee delivery if everyone who’s long right now stands for delivery. The system has never been “stress tested” IMO to know what would happen in this case if everyone stood for delivery. Obviously, there is not enough silver in the wharehouse right now to cover the current outstanding contracts. 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? Futures Broker: I don’t have an opinion on them. 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? Futures Broker: I think the amount is especially small given that they are one of the largest physical suppliers overseas. 75 million ounces is not a lot inventory if a few large institutional investors came in and bought up all the supply. 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? Futures Broker: My guess is that a lot of this volume is not actual physical silver but derivitives of silver. 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? Futures Broker: It doesn’t surprise me in the least that MS would charge for silver that is not there. You’re right to be suspicious of them. 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? Futures Broker: I do. I believe silver has tons more upside than gold right now because of the silver/gold price ratio disparity now of about 70 to 1. 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? Futures Broker: Yes I’ve been following the silver shortage news very closely. I’ve especially appreciated your analysis the last few years. The shortage news is exciting for me because I believe it’s opportunity knocking for those that take advantage of it. 21. Is there any indication that 1000 ounce COMEX bars are in short supply, and if that were to happen, how would we know? Futures Broker: I have anecdotal information from my contact at my clearing firm who says a lot of Vision Financial Markets clients have been taking delivery of their silver contracts. He said his contact at the HSBC wharehouse says that silver is flying off the shelves right now like he’s never seen. 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? Futures Broker: As someone who is very educated from the Austrian Economic school of thought, I am very concerned that all this new paper money is going to cause hyper inflation very shortly. 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? Futures Broker: Absolutely a fair assumption. 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? Futures Broker: I would trust the futures contracts more right now, because I have had clients take personal delivery of their silver for the past few years. ergo I know there is still silver in the wharehouse to back up some of the contracts. I don’t believe the ETFs numbers at all that they are backed by actual metal. 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? Futures Broker: My opinion of companies like Monex that do these types accounts is just go read all the horror stories of them from the Better Business Bureau. They chage high commissions and most customers lose their money I have heard. 26. If someone buys a silver futures contract through your brokerage, could you help them take delivery? Futures Broker: Yes 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? Futures Broker: It would all depend on the individual investor’s risk tolerance, but I would be able to taylor a program for each investor according to his needs. 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? Futures Broker: I guess those dealers have a right to sell silver that way, but I wouldn’t have my own money floating with them for that period of time. I think if you are ready to invest actual money today, you should get your metal immediately. 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? Futures Broker: Thank you Jason for giving me a chance to answer these questions for all your readers. I believe as you do that silver is still a great investment opportunity right now. I’ve been a licensed futures broker now for over 12 years. I think I would be able to add a lot of value to someone’s silver investment program. Feel free to call or email me with any questions you may have.
Allan Bartlett
Excel Futures
Jason Hommel |