Precious metals, silver in particular, have rallied relentlessly but are overbought and subject to Fed disappointment, writes Carley Garner.
We can't help but feel the gold and silver bugs have gotten carried away with their expectations of Federal Reserve Fed Funds rate cuts. In fact, both gold and silver have climbed in the face of a higher dollar and overbought conditions. Even if the precious metals bulls are right in the long run, the market is overdue for a correction in the short run. Getting involved in a bearish speculation using short futures contracts entails more stress than we are willing to take, but we have found a way to play it with options with relatively tame risk exposure, respectable profit potential, and lasting power.
We like the idea of selling the October silver $18.00 call for about 20¢ and purchasing the September $18.50 call for about 6¢. The net credit on the trade will roughly be 14¢, or $700 in premium before considering transaction costs. While this certainly isn't a get rich quick type of venture, silver is currently trading near $16.60, so this trade gives the silver market roughly $1.40 in room for error. In other words, the trade doesn't get in trouble at expiration unless silver is trading above $18.00.
Because we are using options with different expiration dates, it is important to note that the risk in this trade is limited while the September option is in place but becomes an unlimited risk venture if the trade isn't adjusted, or offset, in 33 days upon expiration of the September options (the October options expire in 62 days).
Nevertheless, we expect to be out of this trade before that deadline. The risk of the trade prior to the expiration of the September option which acts as insurance, cannot be accurately calculated but it "shouldn't exceed the intrinsic risk of about $1,800. If something dramatically goes wrong with the trade, we would be prepared for a potential drawdown of about $1,500 to $2,000 per lot. However, it would take a highly unusual move for that to occur. The profit potential is limited to the premium collected of about $700 minus transaction costs. The margin on this trade is $889, making the potential return on investment rather attractive should it work as designed.
Carley Garner is the Senior Strategist for DeCarley Trading, a division of Zaner, where she also works as a broker. She authors widely distributed e-newsletters; for your free subscription visit www.DeCarleyTrading.com. She has written four books, the latest is titled “Higher Probability Commodity Trading” (July 2016).
