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How to Buy Silver at a 10%-20% Discount

Commodities / Gold and Silver 2010 Dec 30, 2010 - 11:49 AM GMT

By: DailyWealth

Commodities

Best Financial Markets Analysis ArticleBrian Hunt writes: Sooner or later, every precious-metal investor is confronted with a big problem...

It goes like this: First, a big bull market in gold and silver – like the one that started in 2001 – enjoys a major run higher. (Think back to when gold shot from $650 an ounce in July 2007 to $1,000 an ounce in early 2008.)


Second, you get a holiday bonus or a cash windfall of some kind. You'd like to place a portion of this cash into precious metals. But after such a huge run higher, you feel like you've "missed the boat." You're worried you're buying near a peak.

You're facing a problem that can be solved with a little-known technique using the options market... one that allows you to buy gold and silver at discounts of around 10% to 20%.

This technique is called "selling puts."

When you sell a put option, you agree to buy an asset at a predetermined price at a predetermined time. Used properly, selling puts is an incredibly powerful tool.

To get an idea of how selling a put option works, let's use an example. Let's agree to buy shares in the major silver fund, SLV.

The silver fund trades in lockstep with the actual price of an ounce of silver. Right now, SLV trades for about $28.50 per share.

Let's say you'd like to own 100 shares of SLV. But you're worried silver is too expensive. You'd like to buy it a little cheaper than its current price. You'd like to pay, say, $26 per ounce for your silver. Here's what you do...

You agree to buy SLV for $26 per share about four months from now. You do that by selling a put option on SLV with a "strike price" of $26 and an expiration date four months down the road. As I write, this option is trading for around $1.50 (it's a bit less than that, but we'll use $1.50 to keep the math easy).

The standard size of a contract in the options market is 100 shares. You want to buy 100 shares, so you sell one option contract. You receive $150 ($1.50 per option x 100 shares per contract).

This trade can play out in two ways...

1) Silver stays above $26 or continues to rise.

No one will sell their SLV shares to you at $26 if SLV is trading at $30 per share. If the price of silver continues to rise, you simply pocket the $150 you collected from selling the puts. You can repeat the process and collect another round of income.

Collecting a "free" $150 isn't bad. But we're much more interested in scenario No. 2...

2) Silver falls below $26 over the next four months.


When the time comes for your option contract to expire, your broker will automatically buy 100 shares of SLV for $26, just as you agreed to. (Make sure you have the money to cover this trade ready.) Since you received $1.50 per share for agreeing to buy SLV for $26, your real cost is $24.50 per share.

If you bought 100 shares of SLV today at $28.50 per share, it'd cost you $2,850. If you sell a put option today and buy four months from now, your real cost will only be $2,450. You're able to save $400 (before transaction costs) and pick up silver for 14% less than it cost four months earlier.

(Keep in mind: This is just an example. With this size position, transaction costs would eat into your gains.)

If you're looking for even bigger discounts, you can go farther out in the calendar.

To become eligible to sell puts, you must contact your broker. He'll initiate paperwork for you. If you're not familiar with options, it's best to spend a good amount of time studying how they work before putting on these sorts of positions.

But if you're worried you've missed out on a big run in precious metals – or any trade, for that matter – it's more than worth putting the time in to get a safe, double-digit discount.

Good trading,

Brian Hunt
P.S. If you're looking for more unique ways to own silver, don't miss my colleague Doc Eifrig's strategy that allows you to buy real silver for much less than Wall Street charges for paper creations like stocks and funds. In fact, you can get started with this silver investment for around $2.08. Click here to learn more.

http://www.dailywealth.com

The DailyWealth Investment Philosophy: In a nutshell, my investment philosophy is this: Buy things of extraordinary value at a time when nobody else wants them. Then sell when people are willing to pay any price. You see, at DailyWealth, we believe most investors take way too much risk. Our mission is to show you how to avoid risky investments, and how to avoid what the average investor is doing. I believe that you can make a lot of money – and do it safely – by simply doing the opposite of what is most popular.

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Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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