On Jan. 14 on StreetAuthority's sister site ProfitableTrading.com, I wrote: "Gold and silver prices have taken a dive in the past two and a half years. Silver prices have been cut in half since their 2011 highs, while gold 'only' shed about a third of its value since then. Currently, silver is trading around $20 an ounce, and gold is trading at about $1,250 an ounce."
Well, not much has changed in the past two weeks. Prices are slightly lower with silver at $19.70 an ounce and gold at $1,245.80.
One company that is shielded from these fluctuations in prices is Silver Wheaton Corp. (NYSE: SLW). Based in Vancouver, British Columbia, the company basically secures long-term purchasing agreements associated with silver and gold around the globe at a fixed price.
Currently, it has more than 20 agreements associated with 23 mines. This allows the company to pay dividends on a regular basis without worrying too much about fluctuations in metal prices.
As an example, Silver Wheaton agreed to purchase 25% of all the silver produced by Goldcorp (NYSE: GG) at a mine in Mexico at $3.90 per ounce (remember that silver is currently at $19.70 an ounce), along with an upfront cash payment of $485 million. That's an estimated 7 million ounces per year for the next 22 years. And it has similar agreements with the other mines.
Below is a chart of SLW with a black line representing the Market Vectors Gold Miners ETF (NYSE: GDX). As you can see, SLW has closely tracked this popular mining ETF, and both are above their 50-day moving averages.[More from StreetAuthority.com: ]
On the fundamental side, its trailing price-to-earnings (P/E) ratio of 17 is in line with the SPDR S&P 500 (SPY). Margins are very healthy with a gross margin of 64%, operating margin (after direct operational expenses) of 60%, and profit margin of 56%.
The company has only 27 employees, so labor costs are not an issue. Additionally, since SLW does not operate any of the mines and simply has purchasing agreements with them, capital and mining costs are also not an issue.
Even if silver and gold prices stay where they are, SLW should make money. Gold would have to drop 68% before it would negatively affect SLW, and silver would have to drop more than 70%. And if metal prices go up, SLW will make even more money, which should be reflected in the share price.
SLW pays a $0.36 annual dividend for a current yield of 1.6%. But we can turbocharge the income on this stock with a covered call strategy.
A call option is an option to buy or sell shares at an agreed upon price (the strike price) within a certain period of time. The buyer of a call option purchases the right but not the obligation to buy the shares at the strike price.
The seller of a call option (also known as the writer) sells the right to the buyer for a payment known as a premium. In doing so, the seller assumes the obligation to deliver the shares at the agreed upon price should the buyer choose to exercise her or his right.[More from StreetAuthority.com: ]
With SLW trading at about $22 per share at the time of this writing, we can buy 100 shares and simultaneously sell a February call option with a $22 strike price, which is currently trading for about $0.80 and expires on Feb. 22.
Since we receive $0.80 for selling the call, our net cost is lowered to $21.20 per share. To give you some wiggle room, I like this trade at a net cost of $21.25 or less.
Here's how this covered call trade could work out:
If the shares stay above the $22 strike price, the buyer will buy the shares from us at $22, giving us a gain of at least $0.75 per share, or 3.5% in 23 days. This works out to a 56% per-year rate of return.
If SLW trades lower, we would not experience a loss unless it falls below our net cost of $21.25 or lower, giving us a cushion of more than 3% at current levels.[More from StreetAuthority.com: ]
If SLW is below $22 on the third Friday of February, then the call option will expire worthless. We then have the ability to sell another call option against the shares to generate more income and lower our cost basis further.
So, using a covered call strategy allows you to generate income as you wait for more upside in SLW while protecting yourself on the downside.
This article originally appeared on ProfitableTrading.com:
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