The Gold Futures Market is another way to make money with gold. However, it is also risky and could cost you a lot of money if you don't know what you are doing.
Traditionally, the futures market was a way for farmers to guarantee a future sales price, with a ready buyer, on crops or livestock that would not be ready for market until some point in the near future. Gold mines starting selling futures contracts as well.
A futures contract traditionally lasted for 30, 60, 90 or 120 days. It was a relatively short-term instrument designed to lock-in profits before actually selling your product. Gold futures were sold in 100 ounce increments. That is, one contract guaranteed the future sales price for 100 ounces of gold.
The buyer of a gold futures contract owns the right to buy (take possession) or sell the underlying 100 ounces of gold for the time period stated in the contract. He pays a relatively small premium to the actual owner of the gold for this right.
The investor (often referred to as a “speculator”) can buy or sell the gold for a stated price during the contract period.
Most speculators never take possession of the underlying commodity. Instead, they bet that the value of gold will either go up (a call contract), or go down (a put contract). If you believe that gold will increase in value, you are “going long”. If you believe that gold is going down in value, you are “going short”
For example, lets assume I buy a “call contract” on 100 ounces of gold valued at $850 an ounce. I have the right to buy the gold from its owner for the stated time period (30,60, 90 or 120 days) at the guaranteed price of $850 per ounce.
If gold increases by $50, I can sell the “contract” and pocket the difference ($50 x 100 ounces = $500).
The reverse is also true. I can buy a “put” contract because I believe the price of gold is going down in the near future. In a “put” contract the owner of the gold, or another investor, guarantees to buy the gold at a set price. If gold goes down in value, they still have to pay the price stated in the futures contract.
For example, lets assume I buy a “put contract” on 100 ounces of gold valued at $800 per ounce. If the price drops to $700 during the contract period, the owner of the gold, or another investor, agrees to pay out the difference ($100 x 100 ounces = $1,000) to whoever owns the contract.
The contract itself can be bought or sold in the futures market to other investors. The value of the contract relies on the following:
1. How much time is left on the Contract.
2. How close to the market-price is the price in the contract
3. How many investors want to buy the contract (supply/demand)
Gold futures contracts that are at or over (under in a put contract) the market price are said to be “in the money”. “In the money” contracts are already profitable for investors and thus they are more expensive. Most speculators buy contracts that are not yet profitable, in the hopes that price changes will bring these contracts “in the money”. The CBOE (Chicago Board of Options Exchange) is the marketplace in the United States where gold futures contracts are bought and sold.
Trading gold futures contracts carries the risk of huge losses as well as profits. If the price of gold goes against your contract, you are on the hook for the difference. They should be viewed as a highly speculative investment with a huge amount of risk. Don't bet money you can't afford to lose.
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