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Playing silver: bull or bear with options on iShares Silver Trust

There has been a lot of interest in Silver lately. Silver has been touted as a safe haven in a fashion similar to Gold. Many commentators suggest a 5% to 10% or more allocation towards precious metals as portfolio hedges. Quite frankly, I can’t see investing in Silver (or Gold) just a way to hedge a portfolio. Is 5% to 10% really going to make a difference? Investing enough to actually protect a portfolio would distort diversification. There are many ways to hedge a portfolio that don’t run this risk and I have outlined some in previous articles.

So, does this mean that there is no place for Silver in a portfolio? Certainly not. I think it should be viewed in the same light as any other investment. That is, not as a hedge– but for gain. The view can be taken that Silver is in a bubble, and one can try to make gains as it falls, or Silver can be viewed as an asset that will increase and look for gains on the upside.

I take a slightly different view. Commodities like Silver don’t have dividends, earnings, balance sheets, etc. They are driven more by emotion than demand. As a result, there is a great deal of uncertainty in these types of investments. Whether I take a bull or bear bias, I look to hedge any position in Silver.

I imagine this puts me in the minority. I look to hedge Silver rather than use it to hedge everything else. Keep in mind that whenever a hedge is employed, the objective is to limit downside risk. The offset to this is less upside. Hedging is about “not being killed” rather than “making a killing”. This article will look at Silver from both perspectives: 1) a hedged long bias and 2) a hedged short bias. It is up to the reader to determine which best fits their own assessment at any particular time.

There are several ETFs that provide direct investment in Silve,r and the first step is to pick which is the best fit. Leveraged long or short ETFs, such as AGQ or ZSL, can be immediately ruled out. They are short term trading vehicles and not suitable for my strategies. That leaves three main contenders, SLV, SIVR and DBS. On the surface these seem very similar in composition. However, when using options in a strategy, it is essential to look at the characteristics of the options. In this regard, SLV is the hands down winner for the following reasons:

  1. SLV has weekly options, which provides more flexibility;
  2. SLV is more liquid with extraordinarily more shares traded;
  3. The bid/ask spread is much “tighter”. For example, the January 2012 at-the-money options for SLV has a bid/ask spread of about 1%. The SIVR is closer to 20% and DBS is around 15%.

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Posted by on Nov 20 2011. Filed under Silver stocks. You can follow any responses to this entry through the RSS 2.0. You can leave a response or trackback to this entry

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