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Futures Contract for gold coin

Introduction to Gold Coin Futures

A future is simply a deal to trade gold at terms (i.e. amounts and prices) decided now, but with a settlement day in the future. That means you don't have to pay up just yet (at least not in full) and the seller doesn't need to deliver you any gold just yet either. It's as easy as that.

The settlement day is the day when the actual exchange takes place - i.e. when the buyer pays, and the seller delivers the gold. It's usually up to 10 days ahead.

Gold Futures & Margin

Delaying the settlement creates the need for margin, which is one of the most important aspects of buying (or selling) a gold future.

Margin is required because delaying settlement makes the seller nervous that if the gold price falls the buyer will walk away from the deal which has been struck, while at the same time the buyer is nervous that if the gold price rises the seller will similarly walk away.

Margin is the down payment usually lodged with an independent central clearer which protects the other party from your temptation to walk away. So if you deal gold futures you will be asked to pay margin.

Gold Leverage

Now you can see how futures provide leverage, sometimes known as gearing.

For example, suppose you had $5,000 to invest. If you buy gold bullion and settle you can only buy $5,000 worth. But you can probably buy $100,000 of gold futures! That's because your margin on a $100,000 future will probably be about 5% - i.e. $5,000.

If the underlying price goes up 10% you would make $500 from bullion, but $10,000 from gold futures.

If the price of gold falls 10% you'll lose just $500 with bullion, and your investment will be intact to earn you money if gold resumes its steady upwards trend.

But the same 10% fall will cost you $10,000 with futures, which is $5,000 more than you invested in the first place. You will probably have been persuaded to deposit the extra $5,000 as a margin top-up, and the pain of a $10,000 loss will force you to close your position, so your money is lost.

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