Getting High On Silver ETFs

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Silver ETFs have been the hot ticket item outperforming just about any other investment with put and call options setting a single-day volume record yesterday, according the WSJ (subscription required):

Silver stole the show in the options market Monday, as traders hoping to profit from the metal’s gains helped set a new single-day volume record in “puts” and “calls” for iShares Silver Trust.

Silver’s rise has been nothing short of meteoric, with investors piling into the futures market, the silver exchange-traded fund and other vehicles. They have flocked to the metal in lieu of currencies, to build inflation hedges or to avoid spending money on pricier gold. With Monday’s gains, the price of silver has risen more than 52% this year. The ETF finished 30 cents higher, or 0.7%, at $45.83, after jumping as much as 3.2% earlier in the session.

Market participants said the latest options rush was driven by speculative money attracted to silver’s volatile price movement, and also by investors who are reluctant to hold big positions in silver futures or in the ETF itself but still want to profit. In choosing options instead of the underlying instruments, traders have the right, but not the obligation, to buy or sell the underlying shares.

“It’s very challenging to step in front of this,” said Michael Khouw,

director of equity-derivatives trading at Cantor Fitzgerald. “It’s a lot more palatable to say, ‘I’m just willing to buy an option to express my view,’ ” he said. Traders can generally put a smaller amount of capital at risk buying an option instead of the underlying stock or index, though they risk losing the entire investment if the envisioned scenario doesn’t play out.

Among the day’s catalysts, gold and silver surged following a report China’s central bank may set up special-purpose investment funds and a foreign-exchange stabilization fund dedicated to currency interventions. Stabilization funds generally include gold among their holdings.

Investors were also eyeing the Federal Open Market Committee’s meeting Tuesday and Wednesday, anticipating news on the Federal Reserve’s bond-buying program.

The activity was in contrast to the more guarded tone in silver options lately. The market has seen more large bearish and protective-looking trades in recent weeks, as traders picked up hedges against or bought what some market analysts called “lottery tickets” that profit in case silver implodes.

The “open interest,” or the number of silver ETF contracts active in the options market, has also hit all-time highs recently, as more investors trade the metal and related instruments. In total, about 919,000 call options to buy the silver ETF changed hands Monday, compared with 515,000 puts to sell it.

What goes up must come down, and the faster it goes up, the faster it will come down eventually. I consider this a speculative silver feeding frenzy, which is not recommended for the faint of heart.

Clearly, a lot of investors are participating via options, where the risk is limited to the premium paid and not a penny more. Trying to purchase outright long ETFs in SLV at this time is simply asking for trouble, and I certainly would not recommend it.

Disclosure: No holdings

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