Options Theory: The Silver Cash Flow Challenge
The appeal of cash flowing a commodity is obvious. And by “cash flowing” I mean using options strategies like covered calls and naked puts. Unlike a stock, commodities like gold and silver (and there accompanying ETFs GLD and SLV) will not go bankrupt. So they have a theoretical floor somewhere north of zero that minimizes the risk of holding them over the long haul.
But stocks and bonds (and cash for that matter) offer something that commodities don’t: a built-in income stream. While stocks pay dividends, bonds and cash pay interest. Lately, that interest has been measly, sure, but it’s at least something.
Of course, many are happy to forego the income stream offered by said assets in exchange for the safety afforded by commodities. But what if you can have your cake and eat it too? What if you can own gold or silver for its security and hedging prowess but generate cash flow along the way?
That sounds like a win-win. Unfortunately, in the case of SLV, which is the product traders use to buy silver, using covered calls or naked puts as your cash flow generating mechanism is challenging.
Today I want to talk about why.
First, selling covered calls/naked puts caps your upside on a monthly basis. This is a fair trade-off if you’re receiving adequate compensation. Otherwise, it’s dumb.
Let’s say you own 100 shares of SLV at $16.11 and want to sell a one month $16.50 call. Right now you can sell the Dec $16.50 call for 17 cents. After commission that 17 cents is probably more like 15 to 16 cents or roughly 1% of the stock price. An attractive rate of return for a covered call is more like 3%.
Is it worth obligating yourself to sell the stock at $16.50, thus sacrificing any additional upside over the next month, in exchange for getting 1% of potential cash flow/protection? Bear in mind that SLV has an Average True Range (ATR) of 23 cents right now. So all it takes is one down day to wipe out the 17 cents from the covered call.
For me, the answer is no.
Now, why is it that option premiums are so cheap on SLV? It’s because of the implied volatility for silver options has fallen to the basement. Perhaps you didn’t know but there is an index for SLV implied volatility. Consider it the VIX for silver. The ticker is VXSLV. Take a look at its six-year history:
Right now we are at the low end. That means SLV options are as cheap as they’ve ever been and that is why trying to cash flow SLV this year has been an outright joke.
In case you were wondering, gold also has an implied volatility index that trades under the ticker GVZ. And, yes, it too has fallen into the abyss shrinking option premiums in the process. Traders trying desperately to squeeze some income out of their precious metal holdings curse these low volatility readings every month. Trust me.
Perhaps someday implied volatility will rise again bringing new life into cash flow strategies for silver and gold. Until then we all have to face the reality that SLV and GLD are sucky underlyings for premium sellers.
