New Silver ETN Offers High Income Potential

NEW YORK (TheStreet) -- A few months ago I wrote about the then new Gold Shares Covered Call ETN issued by Credit Suisse .

That exchange-traded note was designed to synthesize a long position in the SPDR Gold Trust . It also synthesizes the sale of calls each month that are 3% out of the money.

The objective of GLDI is to provide investors with exposure to gold along with the opportunity to receive monthly income -- in the form of dividend from the payment of the notional call premium. Investors will enjoy monthly gains in the precious metal of up to 3%.

The months since GLDI's debut have been rough for gold as GLD has gone down 15%. Over the same period, GLDI has declined 15.30% on a price basis but has paid out three dividends totaling 31 cents, reducing the decline by 1.8 percentage points on a total return basis. That means the ETN has outperformed the related ETF slightly. Three months is a small sample size, but it is enough time for GLDI to show any gross flaws.

The reason to revisit GLDI is because of the recently launched Silver Shares Covered Call ETN . The strategy is essentially the same, but the silver ETN is tied to the iShares Silver Trust . The big difference between the ETNs is that instead of writing calls every month that are 3% out of the money, SLVO will notionally sell calls every month that are 6% out of the money.

The reason for this difference is that silver is more volatile than gold, so Credit Suisse believes note holders will benefit from being able to capture more of any potential monthly move higher.

The other nuts and bolts of SLVO are the same as GLDI's. That means it notionally sells calls over a five-day period beginning 40 days before the options expire, holds the cash received, then buys the call options back over a five-day period starting nine days before expiration. Then it pays out the net cash from the option sale seven days after the closed-out option position expires.

SLVO will charge a 0.65% expense ratio. It's important to understand that this ETN won't participate in any monthly gain for SLV beyond 6%.

The SLVO fact sheet at the Credit Suisse Web site notes that based on the first dividend payout, the yield annualizes out to 12.63%. Any future dividends will be based on future call premiums, which are not knowable. The yield could be more or less than 12.63%; it all hinges on future call prices.

Another critical point of understanding is the exchange-traded note structure. ETNs are unsecured debt obligations if the issuer, in this case Credit Suisse. Standard & Poor's currently rates Credit Suisse's long term debt at A+ with a negative outlook. A failure is of course unlikely, but if it happens, note holders could be wiped out.

The role of SLVO in a portfolio would be as a holding in tandem with the more-standard SLV exchange-traded fund. (Investors can make similar combined purchases of GLDI and GLD.)

To the extent that precious metals offer a form of insurance, putting a portfolio's entire precious-metals allocation into a fund that caps the upside (such as GLDI or SLVO) isn't ideal.

Instead, investors could consider a 50/50 split between the traditional fund and the call-writing cousin.

This would create some income and allow part of the position to run in the face of large, fast moves in the underlying metals.

At the time of publication, Nusbaum's firm held shares of GLD on behalf of clients.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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