This Could Be Your Best Precious Metals Trade
Cryptocurrencies have brought attention back to gold. Some advocates of cryptocurrencies are arguing that cryptos, which include bitcoin and Ethereum among others, can serve as a store of value and protect against risk in the long run.
This has historically been one of the functions of gold and other precious metals. Gold has long been a favorite of investors seeking to protect their wealth against the destruction that inflation could bring. Gold has served as a hedge against inflation for centuries.
In addition to protecting wealth against inflation, gold has also helped investors protect wealth against catastrophe. Gold could be used for transactions if currencies collapse in this scenario. That was recently the case in Venezuela and cryptocurrencies augmented gold in the time of crisis.
It is possible cryptos could protect against economic catastrophes in the future but it is also possible gold and other precious metals will serve their historic roles in the future and protect wealth.
Gold Or Silver?
While gold is often thought of as a first choice for hedging, silver could also be considered. Experts point out that silver is a precious metal, and like gold, it has an intrinsic value. Silver is widely perceived to be both a commodity and a form of money.
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They also highlight the fact that silver has been used as a medium of exchange for thousands of years due to its inherent value. The legendary economist Milton Friedman said that the “major monetary metal throughout history is silver, not gold” and originally, money in the U.S. Constitution is defined in terms of silver.
Despite that history, silver is not as attractive as gold to some investors. The chart below shows the price of silver in the top panel and compares silver to gold in the bottom panel.
It is certainly true that gold has been the better performer in the long run. But, when gold rallied in a strong bull market from 2008 to 2011, silver delivered the better performance. This shows its potential value as a hedge in times of crisis.
For investors seeking a hedge, silver could be more attractive than gold because it costs less. At a recent price of about $16.50 an ounce, silver is within reach of many investors. Gold, at more than $1,300 an ounce, may not be as accessible to small investors.
This could explain silver’s price behavior in the chart above. In times of crisis, silver in many ways becomes more practical. Transactions typically involve small amounts and silver could be used for barter. Its lower price makes it easier for investors to own and trade.
In other words, a crisis could lead to increased demand for gold, and silver. While we don’t know when it will happen, we do know that precious metals are an important component of diversified portfolios for many investors.
Options offer a tool for investors to benefit from a potential rise in the price of silver. This means traders should consider buying a call option on an ETF that tracks silver. This is one of the simplest options strategies available. Buying a call option can deliver a gain if the price of the ETF moves higher.
The maximum amount of risk on the trade is determined when the position is opened. A trader can never lose more than the amount they pay to buy a call. The risks and rewards of this strategy are summarized in the diagram below.
Source: The Options Industry Council
The maximum risk is clearly established as the diagram shows while the potential gains are rather large and, in theory, are unlimited since prices can rise to extreme levels.
A Specific Trading Strategy
One ETF that could be used with this strategy is iShares Silver Trust (NYSE: SLV). There are ETFs that track the price of silver miners but moving companies may not deliver the same returns as silver, since the price of the stock depends on the ability of the company’s management to some degree.
This could be a long term or a short term strategy. Since crisis are, by their very nature, usually unpredictable, we will consider it as a long term strategy since that would provide protection for an extended period of time.
A call option on SLV expiring on January 18, 2019 could provide extended exposure to the silver market. An option with an exercise price of $15 is trading at about $1.80.
Buying that call option would require $180 in trading capital since each contract covers 100 shares. This ignores the cost of commissions which should be small, totaling less than a few dollars at a deep discount broker.
The strategy diagram above shows that risk is limited to the amount paid to buy the option. In this case, the option loses 100% of its value if SLV closes below $15 on January 18.
If SLV closes above that price level, the option will have a value equal to the exercise price less the closing price. For a close at $18, for example, the option would be worth at least $3, and the call would deliver a gain of about 67%.
When this call expires, traders can enter another trade to maintain exposure to SLV. With this strategy, they would be able to maintain exposure to precious metals with a predefined, and relatively small, level of risk. An investor can never lose more than they pay when buying a call.
The long call strategy is an example of how options are a versatile tool and could meet many of your trading objectives. In this trade, options provide exposure to a market many traders otherwise ignore, the precious metals market.
They may ignore the market simply because they are priced out of it without the means to buy several ounces of gold. They may also ignore the market because it is inconvenient to buy and sell precious metals. ETFs solve those problems and do so at a low cost making them ideal for many investors.
These are the type of strategies that are explained and used in TradingTips.com’s Options Insider service. To learn more about how options can be used to meet your goals, click here for details on Options Insider