The Frothiness of Silver Options

by Tyler Craig | September 6, 2012 12:49 pm

Though a cursory glance at recent stock market performance would lead many to conclude Ben Bernanke’s Jackson Hole speech last Friday was a nonevent, both silver and gold paint a decisively different picture. On the heels of the bearded one’s remarks, investors piled into these precious metals, driving them up 4.5% and 2.3%, respectively.

At the same time U.S. Treasuries rallied, driving the iShares Barclays 20+ Yr Treasury Bond ETF (NYSE:TLT[1]) up 1.4% on the day. Throw it all together, and it appears Uncle Ben stoked the fire of inflation fears.

Not surprisingly, Friday’s festivities also spurred interest in iShares Silver Trust (NYSE:SLV[2]) options. The uptick in demand boosted the CBOE Silver ETF Volatility Index (CBOE:VXSLV[3]), further propelling a rising implied volatility (IV) tide that began two weeks prior.

With implied volatility now sitting at 35%, premiums on SLV options have risen high enough to make selling them an alluring proposition. The lift in IV couldn’t have come at a better time. With the VXSLV having fallen to a new all-time low around 25% in August, it was becoming increasingly difficult to find worthwhile option selling opportunities.

Given the somewhat frothy option premiums in SLV, let’s highlight two strategies traders might consider to exploit overpriced options.

Covered Calls

Stock traders who own shares of SLV could sell the Oct 33 call for 65 cents or better. Although this obligates traders to sell SLV at $33, they’re compensated by being paid the 65-cent premium. Due to the recent lift in implied volatility, out-of-the-money calls such as the suggested 33 strike can be sold at higher prices than was previously available. The short call will also provide a minor degree of protection in the event SLV stumbles from current levels.

Naked Puts

Craig VXSLV chart 300x217 The Frothiness of Silver Options
Click to Enlarge
Those willing to bet the relatively nascent uptrend in SLV is likely to continue might consider selling out-of-the-money put options. Provided the puts remain out-of-the-money, they will decay day-by-day until they finally expire worthless at expiration. The October 29 put can currently be sold for around 50 cents. In the event SLV remains above $29, the put will expire worthless, allowing traders to capture the entire 50-cent premium.

Admittedly, the price of SLV appears a bit extended in the short term. Traders who think a pullback might be imminent could wait to sell the put until after the expected retracement.

At the time of this writing Tyler Craig had no positions in SLV.

Endnotes:
  1. TLT: http://studio-5.financialcontent.com/investplace/quote?Symbol=TLT
  2. SLV: http://studio-5.financialcontent.com/investplace/quote?Symbol=SLV
  3. VXSLV: http://studio-5.financialcontent.com/investplace/quote?Symbol=VXSLV

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