It's been hard to miss the rally in precious metals this year. While the broader market took it on the chin midway through January, gold and silver prices were finding support. And as equities have had to fight to return to their 2014 highs, gold and silver prices have actually made new highs for the year.
The fact that gold and silver have been dropping for roughly two years helps to make the case for a sustained rally in precious metals. After such a long decline, we may have finally reached the point where a meaningful amount of "true believers" have finally become frustrated enough to throw in the towel. With the last remaining "weak holders" shaken out, sellers may be in short supply, allowing gold and silver buyers to push prices higher for months to come.
It also helps that demand for precious metals from China has been on the rise, with the World Gold Council recently reporting that China's gold purchases have now surpassed those of India. In particular, a surge in physical bar and coin demand from China may indicate that gold purchases represent investments and hedges against inflation rather than simply demand for jewelry from affluent consumers.
While gold may be the "go-to" asset for investors wishing to hedge against inflation, silver has some tremendous properties that appeal to investors and traders alike.
First, silver is both a precious metal and an industrial metal. There are significant uses for silver in the technology field due to its conductivity, in the energy (particularly solar) field because of its reflective qualities and resistance to tarnish, and in the medical field because of its antibacterial nature. Since silver is actually used, in addition to being held as a storage of value, demand can increase both as a function of investors hedging against inflation and as a function of an expanding global economy.
Second, silver has historically been much more volatile than gold. During the recent bear market for precious metals, silver lost roughly 60% of its value, while gold lost only about a third. Silver has rallied more sharply this year, and will likely experience a greater percentage gain if precious metals continue to trade higher.
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With volatility higher for silver, and a bullish backdrop for precious metals, silver appears to be a great candidate for a put selling strategy, which will allow us to capture income from this rising precious metal.
The iShares Silver Trust (NYSE: SLV) trades in line with the daily fluctuations in spot silver. Silver's volatility has resulted in higher option prices, which works to our advantage as put sellers.
On Wednesday, silver pulled back significantly (as did gold) and continued lower throughout the week, but the decline is still well within the context of a bullish environment for precious metals. For its part, silver has not even begun to close the gap created when it traded sharply higher last week, as you can see in the chart below.
The pullback on Wednesday helps to add to the premium in option prices, as lower prices are typically equated with higher risk, and therefore, higher option premiums. So it appears that we are at a perfect spot to be able to capture the maximum amount of income from the trade, and potentially gain exposure to silver as the precious metal is pulling back within a larger bull pattern.
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The SLV April 20 Puts look like our best bet. The contracts are trading for about $0.55 per share (or $55 per contract, which controls 100 shares). So despite the fact that silver is currently trading above $20, we are being paid a healthy premium to sell out-of-the-money puts.
By selling these put options, we are obligating ourselves to purchase 100 shares of SLV for every contract we sell at the $20 strike price. But since we are likely to be able to sell these puts at $0.55, our net price would wind up being $19.45, which is more than 4% below SLV's current price. Given the bullish environment for precious metals, I would be happy to pick up a meaningful amount of silver exposure at a 4% discount.
The more likely trajectory for this trade would be for silver to continue to hold up well, and for us to simply collect the income from selling these puts as we wait for the contracts to expire.
We will need to set aside $1,945 per contract of our own capital, along with the $55 we receive from selling the puts, as a reserve in case we wind up being assigned the shares. So with $1,945 in capital set aside, our income of $55 represents a 2.8% profit, which will be realized over 46 days if you enter the trade on Monday. (These calls expire on the Thursday prior to the third Friday of April due to the market being closed for the Good Friday holiday.)
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A 2.8% return over a 46-day period nets out to a 22% profit over a full year's time. This is actually a very attractive rate of return considering the low amount of risk in the trade we are taking and the potential for a much larger return if we become obligated to buy shares of SLV at a discount.
I am excited about this precious metal income opportunity, along with the other miners we have recently discussed. Selling puts in a bullish environment, especially one where investors are uncertain and put premiums are high, can be one of the best ways to generate investment income.
This article originally appeared on ProfitableTrading.com:
The Best Precious Metals Play the Market Has to Offer Income Traders