Futures contracts provide investors with a more flexible way to invest in precious metals without the need for investing the full amount up front. To buy or sell a futures contract, investors need not put up the whole value of the contract, but must instead pay a margin deposit as a show of good faith that they will make good on the contract.
How futures contracts work
Futures contracts are a contract for the future sale of an item specifying the date and place that the sale will take place. The contract will also address issues such as ownership and constructive possession of the gold, insurance details and the total sum of the margins.
The idea behind futures contracts is that it allows both consumers and producers of gold to manage gold price risk by locking in the price they wish to buy/sell that product for in the future. For investors, gold futures offer them the chance to invest in the future price of gold for only a fraction of the total cost of the contract. Most of the time, the futures contract isn’t actually settled financially as the contract is sold on before any physical gold changes hands.
Why invest in futures contracts?
Investors of futures contracts fall into two main categories. Hedger and speculator. Hedgers purchase gold futures as a hedge in order to against the price of gold going up or down whereas speculators hope to make money by taking advantage of favourable price movements in the market.
An example of a hedger might be someone who believes the price of gold will rise and wants to take out a futures contract to lock in a guaranteed price should prices indeed go up. This way they can offset any future price increases by selling the futures contract.
How else can you use futures?
A speculator, on the other hand, hopes to benefit from market volatility by gambling on potentially favourable price movements. For example, imagine you purchased a futures contract when gold prices were at their lowest and the value of gold suddenly shot up, you could then sell it on at a profit. Alternatively, if you thought gold prices were likely to go down, you could then sell your gold futures while their prices were still at a peak.
The best part….
One of the main benefits of investing in gold futures as opposed to buying gold outright is that it requires considerably less capital. The higher amount of financial leverage afforded by gold futures also provides a higher risk/higher return investment.
The disadvantage of futures contracts versus physical gold purchases, however is the risk that you could lose greater sums of money if the price of gold moves quickly in the opposite direction to your futures bet.
Long/short positions & gold options
When investing in gold futures you have the option to take up either a long position or short position.
If you think the price of gold is likely to go down, then you might take up a short position on futures contracts. In which case you would pay a margin price to take temporary ownership of the stock and sell them straight on. If the price of gold then goes down, you can then buy the gold back at a profit before returning the stock to the original seller, having made a profit. The main risk of taking out a short position is that if the market doesn’t go the way you predicted you will still have to return the gold even if you have made a loss on it.
If you think the price of gold is likely to go up, then you would then opt for a long position on futures contracts. This is where you would take full ownership of the stock and hold on to it in the hope that gold prices go up over time.
Gold options are slightly different to futures contracts. An options contract allows an investor to make a bet on whether the price of gold will go up or down in the future. On reaching the date specified in the contract, they will then have made a profit or loss based on the difference between where the price actually finishes and how much they’ve predicted it to go up or down by.
Here’s the deal…..
Options contracts are divided into two classes, either calls or puts. If you think gold prices will go up, you would purchase Gold call options. If you believe that gold prices will fall then can buy gold put options instead.
Overall options are a higher risk investment than buying physical gold as you could lose all the money you have invested if the market turns against you.
Discover more about the gold investment market with Physical Gold
Physical Gold are specialist brokers in gold and silver. We offer a wide range of gold based investments as well as providing additional insight into the industry and all the latest news and tips on investing. (See our insights page) For more information please contact one of our friendly and helpful advisers on 020 7060 9992.
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