Why a $1m short-option against July silver is not so crazy
Posted on 12 April 2011 with 10 comments from readers
The silver price dropped back below $40-an-ounce as news of a $1 million short-option just written against silver delivered in July circulated through the trading pits yesterday.
Silver bugs will not like this but there is logic here. If the stock market pops, and the rally looks on its last legs as profits expectations are now too high and QE2 is about to end, then commodity prices will be dragged down too.
Trader logic
Now silver has been the best performing commodity this year. Logic would suggest that means silver also has the most to fall in a correction. Capture that price fall with a well-timed option and you make a very considerable fortune. July and August are, for good measure, usually low months in the precious metals price cycle.
Yet this is just a gamble on market timing. ArabianMoney has been expecting a stock market correction for over a year and has been wrong, albeit our enthusiasm for precious metals has been ample compensation.
So the event that will make this anti-silver bug a fortune may just not happen. Or, more likely, it will happen but not as this speculator hopes. Silver could indeed plummet for a few weeks and then rebound even higher by July, leaving this guy $1 million out-of-the-money.
Timing silver prices is a fool’s errand. Unless you have a time machine your only hope of catching the upside waves of this highly volatile commodity is to stay fully invested for years until you have such a fantastic profit that you decide to cash out. It is also notable that 2008 aside, silver has performed better than gold in previous financial crises (click here).
Long-term position
You are then speculating only on the future of precious metals, not the wild swings (or lack of them) in the market price. Given that fiat money printing is out-of-control around the world it does not require much judgement to see that the only way is up for precious metal prices with their fixed supply and traditional role as money.
Of course, the $1 million silver short-option could be the trade of the year. Shorting a falling stock market is a route to a fortune if your timing is accurate. But many shorts have lost money over the past 18 months waiting for just that event.
ArabianMoney has silver as our top tip for 2011 (click here). Any price set back now will be more than made up in the autumn, and will most likely just be a dip on the parabolic up curve this year.
10 Comments posted by readers:
Is a short option always a bet on the price falling? Can it be a bet on a price rising or would that be a put option?
Is a long option, like a short one, a bet on the price falling but over a longer period time? If so, what do you call a bet on the price rising over the longer term?
Ed Note: Yes. No and Yes. No. Long.
I appreciate that this individual or institution will lose their premium, paid for the short option contract on silver being below $40 per ounce in July, if the price is found to be above this level at that time.
How, though, does he make a fortune, as you say he will, if he’s correct and the price is below $40 in July?
Ed Note: Well, his option was struck at $25 so that would give him say $16 profit per share on last Friday’s price. Bloomberg says ‘The 100,000 puts, or options to sell 100 shares each of the iShares Silver Trust (SLV) at $25 by July, changed hands at the ask price of about 10 cents.’
There are so many cross-currents to consider when determining the direction of the market and individual sectors, that it would be foolish to anticipate a price reduction in silver at this point. Whoever made the short option must have some very deep pockets, like a bank perhaps. Great way to drive the price down, huh?
I would not short Silver quite yet. I found Silver to be quite bullish yesterday on the dips as many buyers were not allowing Silver to go down. I was trading SLV options until around 3:30 AM my time here in Taiwan. I think that they will not allow SIlver to go under $40 before options expire this week. With that in mind you will see that every time Silver dipped under $40 they pulled it back up again. $40 is a key number these days. If any move happens I reckon it will take place next week after options expire on the 16th of this month.
Ed Note: With gold pulling back to $1,450, Richard Russell says “buy again,” if you’ve been holding off.
“Because the precious metals are in a massive bull market,” writes the dean of newsletter men, “many eager amateur analysts are now trying their hand on calling ‘the top.’ This is a hopeless and ridiculous endeavor during a powerful bull market.
“Much of this top-calling is done by an anti-gold element: those who dislike gold or those who have missed the entire gold bull market. My advice all along has been to ‘ride the bull’ and to ignore the ‘top callers.’
“Stay invested in the metals until they exhaust themselves in panic buying.”
Ed., thanks for your two notes. I am still trying to figure out the second one but the information is there.
With regard to this bet, I heard on BBC radio that maritime authorities are considering pulling the plug, within two months from now, on manning ships bringing oil from the Gulf through the Arabian Sea and Indian Ocean to the Gulf of Aden.
Since about 40% of world oil is carried in this way, there will be a catastrophic rise in oil per barrel.
The shipping people are alarmed by a change in Somalian piracy whereby they operate from mother ships far out into the Indian Ocean so that they can attack more shipping more often more effectively.
The two months’ threat may just be a threat by the shipping companies since the politicians are being feeble about this problem. However, a threat will raise oil prices as well.
So, I wonder if the short option buyer is going to lose this bet since two months takes us perilously into June.
Ed Note: Good point – betting on totally unpredictable events is foolish.
Sounds to me like a bet that commodities will drop as soon as QE2 ends. This sounds like a risky gamble to me, what if commodity prices only stabilize? I heard a very interesting theory yesterday on CNBC. What if after QE2 is done, nobody wants to buy treasuries because of other factors. If interest rates are not raised quickly enough that could be more inflationary than QE2.
For a big investment bank or a hedge fund, taking a $1 million short position for July ‘10 options ain’t a “totally ridiculous idea, depending on the striking price.
Yes, it’s a fool’s errand, but if the firm that made that short position has close ties to JPM/FED machinery, they may have inside info on what JPM/FED plans to do regarding silver price suppression in the two months ahead. The fraudulent NY Banks make their money on volatility, and we already know that they will be throwing fuel on the volatility fires, not only for gold and silver prices, but for other commodities as well. Look at how these vultures are attacking the copper market now. Go here:
http://www.zerohedge.com/article/goldman-goes-trifecta-lowers-2011-copper-price-target-11000-9800mt
While it’s highly likely that those options will expire out-of-the-money, there’s a very small probability that the buyer could make out well. And since we’ve already surmised who the likely buyer is, $1 million is nothing to them; it’s like the average investor spending (and losing!) $500 in the options market.
Could the opportunistic shorter have heard about Mr. Obama’s plans to cut the deficit and he is acting on that?
Mr. Obama promised to cut the deficit IN HALF by January 2013.
“This will not be easy. It will require us to make difficult decisions and face challenges we’ve long neglected. But I refuse to leave our children with a debt they cannot repay”
Breathtaking stuff.
Whoops he said that in February 2009!
http://www.zerohedge.com/article/obama-speech-details-leaked-promises-cut-4-billion-deficit-over-next-12-year
The United States Ministry of Truth is about to repackage a new version.
Well, its highly likely its an institution that hopes to drive silver down by generating allot of buzz to scare people out of silver.
At the same time I doubt most banks would permit this sort of risky action.
So my guess its a bank, that already has much risk exposure to a high silver price currently and so are desperate to take the shine off silver.
@ Bernard M.A. Doff: Well said! . . . except for your opening sentence!
Even the So-Called 2010 Budget Cuts Were Just Smoke & Mirrors:
Mr. Obama has no plan. Even the budget compromise last week (a paltry $38 billion in 2011 budget cuts, which is less than .5% of the budget!) didn’t involve any real cuts. These “cuts” were made through accounting gimmicks for “left over” 2011 funds which had not yet been spent.
Any American Family Can Agree to 1% Budget Cuts:
Even the poor folks in the US (and there are many!) can easily cut 1% out of their annual budget . . . but not the US government!
What Obama Truly Cares About:
Sadly, Mr. Obama is a narcissistic charlatan who will say and do anything (including changing his mind frequently!) in order to maintain “adoration” of the masses. Nothing else matters to him.
Clueless on the Potomac:
Two years ago, in April 2009, when the FED began massive printing of US dollars (for additional bailouts of banks, propping up US stocks, etc.), he stated publicly that Americans shouldn’t be afraid of large deficits, yet was clueless about what needed to be done; as a result, he believed the advice of madman, Lawrence Summers (his chief economic advisor), the High Priest of the discredited economics school of Keynesian thinking.
Caution: The Adoration Level is Dropping:
Interestingly, this “adoration” from folks outside the US has slowly eroded over the past 2 years, yet for some strange reason, a reasonably large percentage of the US population, including those who have been disenfranchised, still cling to his “Yes, We Can” mantra.
Significant 2012 Budget Cuts? Hmm, Unlikely:
Also sadly, it is virtually impossible for the jackals in DC to agree on anything, or make any significant cuts in the budget deficit unless there is a very major crisis in the US. So what we are witnessing is simply theatrics and disgusting politics, as usual.