How Does Buying Copper Futures Work?

The copper in a penny became more valuable than 1 cent, so it's been largely replaced with zinc.

The copper in a penny became more valuable than 1 cent, so it's been largely replaced with zinc.

Copper is ubiquitous. It’s found in water pipes, pennies and electrical wiring, and is used in hundreds of other applications. Copper futures are contracts that specify the delivery of a stated quantity and quality of copper at a future date for a stipulated price. Futures contracts can expire after a period ranging from one month to several years. Upon expiration of a copper futures contract, the buyer must accept delivery and pay the contract seller, who is obligated to deliver the copper at a particular location within a range of dates.

Brokerage Account

The first step in buying a copper futures contract is to open a futures trading account with a registered broker. Once you are set up, you must select a particular contract to buy. Copper futures trade on several futures exchanges, including the New York Mercantile Exchange (NYMEX) and the London Metals Exchange (LME). Each exchange has its own copper contract specifications that traders should fully understand before committing to the purchase of a contract.

Contract Specifications

On the NYMEX, a copper contract represents 25,000 pounds of Grade 1 electrolytic copper cathodes. At $3.70 a pound, each contract would be valued at $92,500. To purchase a contract, a buyer must deposit $3,850 initial margin into the brokerage account as collateral. Once purchased, the buyer must maintain margin of $3,500 per contract in the account. In this example, a new contract is leveraged 24 to 1 — every $1 in margin controls about $24 of copper. Leverage, or the control of an asset for a relatively small amount of cash, magnifies the potential returns -- and risks -- of changes in copper prices.

Daily Settlement

Due to the high leverage of futures contracts, exchanges require that profits and losses be settled daily so that both parties to the contract always have sufficient funds deposited to pay for losses. The NYMEX shuts down for half an hour every trading day and calculates the day’s price changes of all contracts. Higher prices represent gains for contract buyers, and lower prices benefit sellers. The change of value in each open contract is added to the gaining brokerage account and subtracted from the account with the loss. If a brokerage balance falls below the maintenance margin requirement, the broker will immediately issue a “margin call” demanding more cash. Failure to quickly respond will cause the broker to liquidate the contract.

Final Settlement

Even though a copper contract calls for physical delivery upon expiration, the buyer can close the contract any time before expiration to avoid receiving 25,000 pounds of copper cathodes. Buyers close contracts by “offset,” in which an identical contract is sold by the buyer, canceling the original purchase. Since profit and losses have been paid daily, only the offset day’s value change need be paid. Overall profit or loss is the difference between the purchase price and offset price. About 5 percent of futures contracts result in actual physical delivery. Delivery of copper can occur at any warehouse licensed by the exchange.

 

Resources

  • Precious Metals Investing for Dummies; Paul J. Mladjenovic
  • A Trader's First Book on Commodities: An Introduction to The World's Fastest Growing Market; Carley Garner
  • The Futures Game:Who Wins, Who Loses, & Why; Richard Teweles, Frank Jones

Photo Credits

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