The Smart Way to Trade Silver: 200%-Plus Upside with Limited Risk

Right now could be the perfect time to profit from silver. In fact, I think traders could make 200%-plus if silver hits my target price. Let me explain…

Silver lost its luster after the 2011 rally peaked just below the ballyhooed bull target at the all-time high at $50 an ounce set in 1980.  The drop from $48 to the $26 January 2012 lows measures a 45% decline from the heights just one year ago this month.

As a side note, if you adjust that record price for inflation over the 30+ years the real upside target for Silver sits significantly higher at $139.19.  

The iShares Silver Exchange Traded Fund (NYSE: SLV) represents one ounce per share.  With the current price holding roughly around the $30 support area the reward to risk ratio may once again be in the longs favor.



The seven-month trading channel between $34 and $30 could be a setup for an SLV price breakout.  A rally run above the resistance top projects a $4 move, the width of the channel, to $38 and the back up to the original September breakdown area.  #-ad_banner-#

That $38 target is also the halfway bounce of the 2011 highs to this years lows which is a healthy 25% plus higher from here.  Only a weekly close below the December/January congestion action at $28 would reset the bullish base.

As you can see, there’s plent of upside left in silver. However, there’s a better way to profit from silver than buying SLV. A SLV long call option can provide the staying power in a potential larger trend extension.  More importantly, the maximum risk is the premium paid for buying the option

The Options Way: Unlimited Upside Potential with Limited Risk  

One major advantage of using long options instead of buying or selling shares is putting up much less money to control 100 shares — that’s the power of leverage.

Choosing an option can sometimes be a daunting task with all of the choices and expirations.  Simply put, traders want to buy a high probability option that has enough time to be right.

The option strike price is the level at which you have the right to buy without any obligation to do so.  In reality, you rarely convert the option into shares. Simply sell the option you bought to exit the trade for gain or loss.   

There are two rules options traders need to follow to be successful.

Rule One:  Choose an option with 70%-plus probability.  The Delta is a measurement of how well the option reacts to movement in the underlying security. It is important to buy options that payoff from only a modest price move.  There is no need to ONLY make money on the all but infrequent price explosion.

Any trade has a fifty/fifty chance of success.  Buying options ITM options increase that probability. That Delta also approximates the odds that the option will be In The Money at expiration. Buying better options are more expensive, but they are worth it — the chances of success are mathematically superior to buying cheap, long shot Out Of The Money lottery tickets that rarely ever pay off.   
 
With SLV trading at $30.00, for example, an In The Money $26 strike option currently has $4.00 in real or intrinsic value. The remainder of any premium is the time value of the option.

Rule Two: Buy more time until expiration than you may need — at least three to six months for the trade to develop. Time is an investor’s greatest asset when you have completely limited the exposure risks.  

Traders often buy too little time for the trade to develop. Nothing is more frustrating than being right but only after the option has expired premature to the market move.

Trade Setup: I recommend the October SLV $26 Call at $5.00 or less. A close below $28 on a weekly basis or the loss of half of the option premium would trigger an exit.

Looking at the SLV chart above, the $26 level coincides with the 52-week low support.  This option strike gives you the right to buy at the lowest point for the year.  The October option gives the bull trend near six months for development.
 
The maximum loss is limited to the $500 paid per option contract. The upside, on the other hand, is unlimited.

The trade breaks even if SLV is trading at $31 at expiration ($26 strike plus $5 option premium = $31). That is just a dollar above SLV’s current price. If shares hit my $38 price target, the option investment would more than double,  a gain of at least 200%.