Two markets based on the same underlying commodities give traders in gold and silver options and exchange-traded notes (ETNs) more information than would be available from a single market. Price trends and relative changes over time for ETNs can be used to guide trading in associated options, while variations in options pricing suggest possible trades in ETNs.
The market that both options and ETNs depend on for pricing is the futures market. This link provides a strong, timely and dependable flow of information that should be valuable for traders in either or both ETN and options markets.
One key assumption is that changes over time in prices for an ETN and a single futures contract are virtually identical. “Virtually” is the operative word here, because the changes are not completely equal, but equal enough so trades may be based on either an ETN or related futures contract with a high degree of confidence. It is possible to create spread trades without knowing the precise formulas behind the ETN price quotes.
The close fit between price movements of ETNs and futures is shown on “Futures and ETNs” (below). The charts cover the period from January to July 1, 2014, and include December 2014 futures contracts on the two metals and unleveraged ETNs: UGB for gold and USV for silver (E-TRACS CMC Gold and Silver TR ETN).
As expected from past history, silver futures and ETNs are more volatile than similar securities based on gold. The period during June 2014, when silver fluctuated from -6% cumulative percentage price change to 8% compared with gold’s cumulative percentage change from 2% to 8%, is a reminder of prices in June through September 2012, when silver futures and ETN fluctuated from -15% to 10% while gold futures and ETN changed from approximately 0% to 10%.
Based on historical norms, the price swings of silver around gold can indicate potential spread trading opportunities in either ETNs or futures. For example, from June 13 to June 30, 2014, silver USV gained $3.56, from $26.69 to $28.86, while gold UBG increased by $1.33, from $33.31 to $34.64; a net gain of $2.33.
A similar spread using December 2014 futures contracts had silver gaining 1.465 from 19.751 on June 13 to 21.216 on June 30, or $7,325. Over the same period, gold futures increased by 47.9—from 1,274.9 to 1,322.8, or $4,790—a net gain of $2,535 from buying silver futures and shorting gold futures to hedge the trade.
“Spread for gold and silver calls” (below) describes a trade connected to the relatively large negative variation of silver futures and ETNs early in June 2014. Thus, the wide gap between price movements of gold and silver suggests the timing of a trade buying silver and selling gold—depending on a reversal in the gap to provide a hedged profit. Of the three strike prices considered for each metal, the 23 strike for silver and 1340 for gold are chosen because of the possibility of spreading two silver 23 strikes at a premium of $1,020 against a single 1340 strike for gold at a $2,060 premium.
One concern in this trade is the potential for prices to turn down, with silver leading the way because of its inherent greater volatility. Of course, gold should decline as well, which would reduce the risk. In addition, the futures price for silver equals approximately 85% of the selected strike while gold’s December futures price is 95% of the 1340 strike. With gold futures further up the option price curve, as shown on “Spread for gold and silver calls” (below), the increased slope, or delta value, may help it overcome gold’s volatility disadvantage.
Comparative volatilities are displayed on the gold and silver call chart (see page 44). Gold options on June 13 and July 1 are much lower than the silver price curves, and show a slightly lower pattern for July 1 following the erosion of some time to expiration over the period June 13 through July 1. On the other hand, the silver prices (where each dot represents a strike price) increase a noticeable distance, temporarily ignoring the passage of time.