Most Popular
1. It’s a New Macro, the Gold Market Knows It, But Dead Men Walking Do Not (yet)- Gary_Tanashian
2.Stock Market Presidential Election Cycle Seasonal Trend Analysis - Nadeem_Walayat
3. Bitcoin S&P Pattern - Nadeem_Walayat
4.Nvidia Blow Off Top - Flying High like the Phoenix too Close to the Sun - Nadeem_Walayat
4.U.S. financial market’s “Weimar phase” impact to your fiat and digital assets - Raymond_Matison
5. How to Profit from the Global Warming ClImate Change Mega Death Trend - Part1 - Nadeem_Walayat
7.Bitcoin Gravy Train Trend Forecast 2024 - - Nadeem_Walayat
8.The Bond Trade and Interest Rates - Nadeem_Walayat
9.It’s Easy to Scream Stocks Bubble! - Stephen_McBride
10.Fed’s Next Intertest Rate Move might not align with popular consensus - Richard_Mills
Last 7 days
How to Capitalise on the Robots - 20th June 24
Bitcoin, Gold, and Copper Paint a Coherent Picture - 20th June 24
Why a Dow Stock Market Peak Will Boost Silver - 20th June 24
QI Group: Leading With Integrity and Impactful Initiatives - 20th June 24
Tesla Robo Taxis are Coming THIS YEAR! - 16th June 24
Will NVDA Crash the Market? - 16th June 24
Inflation Is Dead! Or Is It? - 16th June 24
Investors Are Forever Blowing Bubbles - 16th June 24
Stock Market Investor Sentiment - 8th June 24
S&P 494 Stocks Then & Now - 8th June 24
As Stocks Bears Begin To Hibernate, It's Now Time To Worry About A Bear Market - 8th June 24
Gold, Silver and Crypto | How Charts Look Before US Dollar Meltdown - 8th June 24
Gold & Silver Get Slammed on Positive Economic Reports - 8th June 24
Gold Summer Doldrums - 8th June 24
S&P USD Correction - 7th June 24
Israel's Smoke and Mirrors Fake War on Gaza - 7th June 24
US Banking Crisis 2024 That No One Is Paying Attention To - 7th June 24
The Fed Leads and the Market Follows? It's a Big Fat MYTH - 7th June 24
How Much Gold Is There In the World? - 7th June 24
Is There a Financial Crisis Bubbling Under the Surface? - 7th June 24
Bitcoin Trend Forecast, Crypto's Exit Strategy - 31st May 24
Zimbabwe Officials Already Looking to Inflate New Gold-Backed Currency - 31st May 24
India Silver Imports Have Already Topped 2023 Total - 31st May 24
Gold Has Done Its Job – Isn’t That Enough? - 31st May 24
Gold Stocks Catching Up - 31st May 24
Time to take the RED Pill - 28th May 24
US Economy Slowing Slipping into Recession, But Not There Yet - 28th May 24
Gold vs. Silver – Very Important Medium-term Signal - 28th May 24
Is Gold Price Heading to $2,275 - 2,280? - 28th May 24
Stocks Bull Market Smoking Gun - 25th May 24
Congress Moves against Totalitarian Central Bank Digital Currency Schemes - 25th May 24
Government Tinkering With Prices Is Like Hiding All of the Street Signs - 25th May 24
Gold Mid Tier Mining Stocks Fundamentals - 25th May 24
Why US Interest Rates are a Nothing Burger - 24th May 24
Big Banks Are Pressuring The Fed To Losen Protection For Depositors - 24th May 24
Another Bank Failure: How to Tell if Your Bank is At Risk - 24th May 24
AI Stocks Portfolio and Tesla - 23rd May 24
All That Glitters Isn't Gold: Silver Has Outperformed Gold During This Gold Bull Run - 23rd May 24
Gold and Silver Expose Stock Market’s Phony Gains - 23rd May 24
S&P 500 Cyclical Relative Performance: Stocks Nearing Fully Valued - 23rd May 24
Nvidia NVDA Stock Earnings Rumble After Hours - 22nd May 24
Stock Market Trend Forecasts for 2024 and 2025 - 21st May 24
Silver Price Forecast: Trumpeting the Jubilee | Sovereign Debt Defaults - 21st May 24
Bitcoin Bull Market Bubble MANIA Rug Pulls 2024! - 19th May 24
Important Economic And Geopolitical Questions And Their Answers! - 19th May 24
Pakistan UN Ambassador Grows Some Balls Accuses Israel of Being Like Nazi Germany - 19th May 24
Could We See $27,000 Gold? - 19th May 24
Gold Mining Stocks Fundamentals - 19th May 24
The Gold and Silver Ship Will Set Sail! - 19th May 24

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

Three Ways to Play the Silver Rally, While Limiting Your Risks with Options

Commodities / Gold and Silver 2010 Oct 13, 2010 - 05:37 AM GMT

By: Money_Morning


Best Financial Markets Analysis ArticleLarry D. Spears writes: With the global economy struggling to sustain even a modest recovery, the U.S. Federal Reserve pledging further quantitative easing if needed, and the dollar and several other leading currencies showing unrelenting weakness, there have been plenty of reasons for precious metals to rally of late - and gold and silver have done just that.

Gold has set a series of all-time record highs over the past five weeks, topping $1,350 an ounce for the first time ever as the dollar slipped to its lowest level since early January. Silver, while still well short of the $50-plus-per-ounce record it set when the Hunt brothers tried to corner the market in 1979, spiked to its highest price in 30 years and almost five times the sub-$5.00 levels it traded at from late 2000 to 2003.

The combination of bullish fundamentals, strong technical patterns and the persistent price advance has pushed coverage of gold and silver from the pages of specialty metals newsletters and Web sites to headline status in the mainstream media, stoking soaring investor interest in the process.

And, according to most analysts, the continuing bullish outlook is warranted. Morgan Stanley (NYSE: MS) issued a new report predicting 2011 gold prices could average anywhere from $1,315 an ounce to $1,512 an ounce.

A number of other sources have forecast gold prices reaching $2,000 to $2,500 in the next few years, and a few - including Money Morning Contributing Editor Martin O. Hutchinson - have made a recent case for the yellow metal skyrocketing to as much as $5,000 an ounce.

Silver backers have been equally positive, if somewhat more conservative price-wise. "The medium-term outlook for silver remains positive ... and we therefore raise our medium-term price target to $25 an ounce," said Bank of America Merrill Lynch metals strategist Michael Widmer.

However, David Morgan, one of America's most respected silver analysts, warns that the metal's recent price surge begs for some caution on the part of those just entering the market.

"I've been bullish on silver for a long time and I remain solidly bullish over the longer term," says Morgan, founder of and publisher of The Morgan Report, "However, the market has been rising steadily for more than two months (since a brief dip to $17.40 on July 28) and it is significantly overbought at current levels."

Morgan notes that there are a lot of professional traders - as well as numerous regular investors who got in early - sitting on some massive profits just waiting for the optimum time to cash in. [Note: The standard Comex silver future represents 5,000 ounces, meaning the December contract's move from the late July lows to a recent close of $23.18 would be worth more than $28,000.]

"If they sell, their inclination will likely be to turn right around and go short, which could trap some of the late-comers into bailing out as well, sparking at least a moderate short-term correction," says Morgan.

How big a correction?

Morgan's best guess, based on his current overbought assessment, is at least 10% - which would carry the December futures price back to $20.90 or so.

In spite of that possibility, Morgan still believes investors who don't yet have a silver position should take the plunge - largely because of the increasingly bullish fundamentals, the upcoming period of highest demand for precious metals (due to Asian buying for cultural reasons and Western jewelry purchases for holiday gifting) and the fact that silver has historically lagged gold in rallies, then made up the difference with large late-stage advances.

The latter factor can be somewhat measured by the silver-to-gold ratio - the number of ounces of silver it takes to buy one ounce of gold. At the height of the financial crisis in late 2008, that ratio soared to a whopping 75:1, then lingered in the 68:1 to 72:1 range until August of this year. The recent silver price spike dropped the ratio to just over 58:1, but it still has a long way to go to reach what was considered "normal" in the past - around 35:1 prior to 1980, with monetary norms as low as 16:1 earlier in the 20th century.

According to some calculations, silver would need to rally another $5 to $7 an ounce just to "catch up" with the gains already recorded by gold - and even more should gold continue to rise. To be precise, if gold rises to $1,500 an ounce in 2011 (as Morgan Stanley estimates), and the silver-to-gold ratio drops to 50:1, silver would have to climb to $30 an ounce.

Three Ways to Play the Silver Rally
So, how do you play the potential continuation of silver's rally - without taking on the excess risk carried by outright futures purchases (where a 10% correction could cost $11,500 per contract) or dealing with the hassles (storage, insurance, etc.) of holding the actual physical silver in coins or bars?

A far better approach if you're risk averse is to employ a bullish silver "option spread." There are two ways of doing this, which I'll illustrate using the closing option prices from Wednesday, Oct. 6:

Bullish debit spread - This strategy involves buying an at-the-money Comex silver call option and simultaneously selling another silver call with a higher striking price to offset the cost. The play has an absolutely limited level of risk, but it also has a maximum profit, which is achieved at any futures price above the striking price of the call you sell.

For example, with the December silver futures price at $23.18, you might buy the December $23.00 call at 98.4 cents, or $4,920 ($0.984 x 5,000 = $4,920) and simultaneously sell the December $24.00 call at 59.5 cents, or $1,525 ($0.595 x 5,000 = $2,975). The net cost would be $1,945 (plus commission) - and that would also be the maximum loss on the play, which you would incur at any futures price below $23.00 an ounce at the expiration of the options (Nov. 24 this year).

The maximum profit on the play, which you would achieve at any futures price above $24.00 an ounce on the expiration date, would be $3,055 (the dollar value of the difference between the striking prices, or $5,000, minus the $1,945 initial cost = $3,055).

Of course, you wouldn't have to wait until expiration. If silver made a big move earlier, you could close out the spread, taking a large partial profit - and, if you were still bullish, perhaps initiating a new spread using calls with higher striking prices or a more distant expiration.

As an example, the 65.6-cent jump in the December silver futures on Tuesday and Wednesday (Oct. 5-6) would have given the holder of $22.00-$23.00 spread opened Monday at a debit of 38.4 cents ($1,920) a quick profit of 19.5 cents, or $975 ($0.195 x 5,000 = $975) - a two-day gain of more than 50%.

And, if you were willing to risk slightly more in exchange for a larger potential profit, you could buy and sell calls with striking prices further apart - say $23.00 and $24.50. (At Oct. 6 prices, that combo would have given you a cost of $2,645 and a maximum profit of $4,855 at any futures price above $24.50)

Bullish credit spread - This strategy is quite similar to the debit spread, but it uses silver put options rather than calls. To initiate it, you would sell an in-the-money December put option (i.e., one with a striking price higher than the futures price) and simultaneously buy a put with a lower striking price in order to limit your risk. The excess money you receive for the call you sell is your maximum profit, which you achieve if the silver futures price rises and both puts expire worthless.

For example, with the December silver future at $23.18 (again using Oct. 6 prices), you might sell the December $24.00 put for $1.552, or $7,760 ($1.552 x 5,000 = $7,760) and simultaneously buy the $23.00 put for 94.1 cents, or $4,705 ($0.941 x 5,000 = $4,705). You receive a net credit on the two trades of $3,055 (less commission) - and that would also be the maximum profit on the play, which you would achieve should the future wind up at any price above $24.00 on expiration day. The maximum loss would be $1,945 ($5,000 - $3,055 = $1,945), which you'd suffer at any futures price below $23.00.

Obviously, the maximum profit and loss will vary depending on the striking prices you choose, and you can again adjust both by widening the spread between striking prices. You can also take an early profit if silver makes a big move, just as with the debit spread.

A third reduced-risk alternative is to use options on a surrogate for silver or silver futures - an example being the iShares Silver Trust Fund (NYSE: SLV), recent price: $22.70. This exchange-traded fund (ETF) seeks to track the price of silver itself rather than silver futures and does so by holding the actual metal. It also has the most actively traded set of options of any of the current silver-linked ETFs, with each option giving you the right to buy (or sell) 100 units of the underlying trust. As such, you can easily adjust the number of outright call purchases to meet your specific risk parameters.

For example, using the closing option prices for Oct. 6, as above, you could buy 10 SLV November $22.00 calls (which expire Nov. 19, versus Nov. 24 for the options on December futures) at a premium of $1.31, or $131 per call ($1.31 x 100 = $131), or $1,310 for the full position. This would be your maximum risk on the play, while your potential profit, which would start building at an SLV price of $23.31 (the $22.00 striking price, plus the $1.31 premium paid), would be unlimited.

If, for instance, silver prices rose to $26 an ounce at expiration and SLV tracked them perfectly, the price of the $22.00 call would rise to $4.00 ($400 per contract), giving you a profit of $2,690 ($4,000 - $1,310 = $2,690) on the full 10-option position.

The SLV options can also be used to structure either debit or credit spreads, as with the options on futures, with the smaller unit sizes giving you maximum flexibility with respect to choosing the number of contracts, striking prices and desired risk/reward levels.

Source :

Money Morning/The Money Map Report

©2010 Monument Street Publishing. All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Monument Street Publishing. 105 West Monument Street, Baltimore MD 21201, Email:

Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investent advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or 72 hours after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Money Morning Archive

© 2005-2022 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.

Post Comment

Only logged in users are allowed to post comments. Register/ Log in