Using silver options to capitalize on the debt ceiling

A silver lining to the debt ceiling?

Yesterday, major bullion bank HSBC raised its price targets for 2013 and 2014 silver prices based on growing industrial demand and increased investor appetite.  Nearly 40% of silver is used for industrial and commercial applications, including use in computer keyboards, batteries and high-voltage contacts including those in solar panels.

With the increased availability of cheap natural gas, government subsidies of clean energy have shifted from wind to solar in the U.K., China and elsewhere.   In China alone, the government plans to grow solar installations from 4-5 gigawatts in 2012 to 21 gigawatts by 2015.  Increased access to affordable tablets and other portable electronics in India and China should also show increased demand for the commodity

Silver also is trading at a historically low discount to gold. On average, gold trades at a price 28 times that of silver, much lower than current levels. If historic ratios were to hold true, silver should be trading around $60. As debates over the sequester ramp up and uncertainty over the debt ceiling looms, it is likely that investors will look to buy metals as a “safe-haven” trade. With increasing demand by commercial and industrial manufacturing, silver should see some significant upside in months to come.

So what are the different ways a trader can take a bullish view on silver?

  1. Buy spot silver. The most direct exposure to the price of silver, but a very capital intensive venture.
  2. Buy the ETF. SLV does a good job of tracking the movement in silver prices, but this is also a capital intensive trade.
  3. Options on silver futures (SI). The best and most accurate way to set up a trade with a good risk vs. reward setup.

Once we know that we want to look at a bullish trade, we can use the options market to come up with a target level to center a trade on. Looking at the price of the at-the-money straddle in the April options, we can see that the market is implying a $1.75 move to the upside or downside by expiration. Once we know what the implied move is, we can look at a trade.

Trade: Buying the /SI Apr 31.75-32.75 Call Spread for $0.25
Risk: $1,250 per 1 lot
Reward: $3,750
Breakeven: $32.00

This trade sets up for a great risk vs. reward ratio and would give a trader three-to-one on their money if silver futures close above $32.75 by expiration.

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About the Author
James Ramelli

James Ramelli is the Moderator of the Live Futures Options Trading Room at KeeneOnTheMarket.com where he actively trades futures and options on futures while educating members on strategies, setups and risk management. He has a degree in Finance with a focus in Derivatives Trading and Financial Engineering from The University of Illinois and has been trading for five years. James appears regularly on Bloomberg T.V. and BNN and writes a weekly column for Futures Magazine.

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