How to Cash In on Super-Coiled Silver

by Tyler Craig | March 21, 2013 11:02 am

Plagued by persistent strength in the U.S. Dollar, commodities have been left behind, watching from afar as the stock rally of 2013 continues its rapid ascent. While the S&P 500 has climbed nearly 10%, the Powershares DB Commodity Index Fund (NYSE:DBC[1]) is down 2% on the year. One of the more lackluster performers within DBC is silver, which has fallen 5% year-to-date.

But while the price performance of silver has been far from stellar, an especially interesting development is afoot in its volatility.

Over the past month the iShares Silver Trust (NYSE:SLV[2]) has been trading in an increasingly tightening range around the $28 level. A series of higher pivot lows and lower pivot highs have come together to form a classic symmetrical triangle. The convergence of the upper and lower trendlines reveals the increased aggression of buyers and sellers.

SLV chart 1024x747 How to Cash In on Super Coiled Silver
Click to Enlarge

The current compression in volatility takes on added significance when we overlay on the chart. The Bollinger Bands are designed to expand when a stock becomes more volatile and contract when it becomes less volatile. Take note of how close together the bands have become in the accompanying chart of SLV.

SLV Bol Band How to Cash In on Super Coiled Silver
Click to Enlarge

The indicator panel below the price chart measures the width between the upper and lower band. Currently, the distance between the two is a mere $2.95.  It’s not only the lowest reading of the past six months; it’s the lowest reading we’ve seen since SLV started trading in April 2006!

Generally, stocks alternate between periods of volatility compression and volatility expansion with one eventually giving way to the other. With SLV more coiled than ever, it’s a good bet a big move is coming sooner than later.

To exploit the anticipated volatility surge, you have two choices. You could wait for SLV to complete its triangle pattern with a breakout and then place a trade in the direction of the breach. Or you could place a bi-directional trade like a straddle in anticipation of the breakout.

If SLV breaks to the topside, consider buying the May 28 call. If it breaks to the downside, consider buying the May 28 put.

If you want to take the bi-directional route you could purchase a May straddle, buying both the 28 call and the 28 put for $1.84. The net debit is limited to the initial debit of $1.84 and the max reward is unlimited. Provided SLV moves enough in either direction, the straddle will turn a profit.

At the time of this writing Tyler Craig had no positions on any of the aforementioned securities.

Endnotes:
  1. DBC: http://markets.financialcontent.com/investplace./quote?Symbol=DBc
  2. SLV: http://markets.financialcontent.com/investplace./quote?Symbol=SLV

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