Silver is on fire

On Feb 21, I predicted that silver could reach $50/oz in 12-18 months. Today, it has surpassed $40/oz. I'm probably too conservative in my assessment. Actually nothing has really changed regarding the fundamentals of silver, and if any, they are more in favor of silver. In other words, the financial situation of the world is worsening everyday, which will only further support the appreciation of the precious metals' prices. Of course, I'm not naive enough to think that the gold and silver prices will only increase from this point on. Some sort of significant correction is still very likely. But the overall long-term picture has become much much stronger for an upward trend for gold and silver. My advice is still the same: if you have not bought any gold and silver, you should consider to buy some immediately to get a foot in and add more if a serious correction comes. It is impossible to time the exact best entry point for any trading. If you do, let me know.

The following is one of my silver positions, which I bought less than a year ago. I'd like to show you with this real example how to use options to minimize your risk.

Symbol:               SLV Jan 21'12 $14 Call   

Current price:   $25.70   

Day change:       $500.00 (4.26%)

# of Shares:        5   

Unite Cost:         $5.60   

Total gain/loss: $10,009.93 (355.58%)

When I bought this call option, SLV (the ETF for silver) was traded at about $19 that was almost the silver spot price at that time. I wanted to buy 500 shares of SLV. If I simply bought outright of SLV shares, it would have costed me $9500. Instead, I bought 5 contracts of SLV Jan 2012 $14 call options (equivalent to 500 SLV shares), which costed me $5.6 per share that equals to $2800 in total. This call option means I have the right (but not obligation) to buy 500 SLV shares at $14/share by Jan 21, 2012 if I want. Since I paid $5.6/share, I'd actually buy at $19.6 ($14+$5.6), which is the true cost base for SLV that is almost identical to the SLV share price at that time. Of course, I'd lose money if SLV drops below $19.6 while I'm still holding this call option before Jan 21, 2012. However, the total loss I could have is $2800, instead of $9500 as compared with directly buying SLV shares. In other words, while I controle the same amount of SLV shares, my risk has been substantially reduced by 70%. So how about the profit part? Well, if you do the math, the absolute amount of gain is almost identical between the two, at $10,000 at the moment:

- The SLV current price is $39.51/share. If I bought at $19 for 500, the gain would be $10255

- The option current price is $25.7/share.  I bought at $5.6, so the gain is $10050 for 5 contracts

In other words, since my cost base ($2800) was much lower, relatively speaking, my gain was much bigger at over 300%, as compared to 100% if I bought SLV shares outright. 

I hope you can see the option power now, but you need to know how to play with it appropriately. Inappropriately your risk can be high.