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Silver: The Smart Money Gets Bearish

Jeff Macke

The sharpest rallies are propelled by the blood of those shooting against them. Whether it's the Internet, housing or RCA in 1928, buyers in the waning stages of a bubble are equal parts latecomers chasing the party and shorts being forced to capitulate by covering. As being "early" is exactly the same as being "wrong" in the trading world, ours is not to say whether it's the chasers or burned shorts that are the dumber money. But the battle lines are being drawn.

Which brings us to the commodity rally still in full swing. In the past two years silver is up from a 12-handle to new all-time highs over $40 oz. Goldman Sachs (GS) and all the other cool kids are looking for a sharp pullback. Of course there is a not-at-all fine distinction between taking profits and putting your money on a short side bet. One trader this week made just that bet by wagering $1 million on July SLV puts over 35% out of the money.

We brought in Interactive Brokers' Senior Market Analyst Andrew Wilkinson to help us make sense of the put position.

"It's actually a very well-timed, very inexpensive wager on the price of silver falling," says Wilkinson. "Plenty of smart money [read: the cool kids] is betting on the commodity rally ending."

How is a million buck bet inexpensive? For one thing, a million bucks isn't what it used to be. For another, as Wilkinson notes, it was a "low Delta trade." In English, that means you can buy a whole stack of option paper for a relatively low price. The unknown silver bear only paid 10 cents a contract at a relatively low volatility. As a result, the trader doesn't actually need to fall 37% by July to make money. Instead the put buyer just needs other traders to think silver might drop that steeply. Wilkinson observes that the put buyer's contracts were trading for 20 cents the day after the million-dollar trade, giving the bear a double on paper.

Putting it all together, we're getting into the most interesting part of any explosive rally -- the part when skeptics start putting their money where their mouth is. Will history judge the current commodities rally as overdue or overdone? Much depends on the next few months. Precious and semi-precious metals aren't generally "supposed" to move in lockstep, as has been the case in recent years. History suggests something's gotta give in commodities or stocks. Will silver and stocks diverge, rally together or get dumped in a heap?

Place your bets or watch from afar; either way the commodity rally is setting up as very interesting theater.

We want to know what you think. Write to us at Breakoutcrew@yahoo.com.