February 27, 2017 - 3:49pm EST by
2017 2018
Price: 17.30 EPS 0 0
Shares Out. (in M): 335 P/E 0 0
Market Cap (in $M): 5,800 P/FCF 0 0
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 5,800 TEV/EBIT 0 0

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I apologize in advance for the non-value oriented nature of this idea.   I think it’s fair to call this one more a pure speculation, which I normally don’t indulge in.   Nonetheless, given the paucity of true value ideas out there right now (did the latest VIC bargain meter really show 1% of you are finding ideas plentiful?) I thought I’d come clean and post an idea that I find alluring, despite not fitting the traditional value motif.    However, I will try to rationalize this idea for a value audience by telling you that it’s not the underlying idea per se where I see the value, but in the options.   In my view, the options market is giving us a very good price to buy exposure to an asset that has exhibited extraordinary volatility in the recent past and is also trading at the low end of its 5-year range.  Also, for anyone whose time is just truly wasted by this one, I resolve to submit my next “true” value investing idea in a timely fashion to this site.

My idea is to buy call options on SLV, which is the iShares Silver Trust ETF.   

Just as a bit of extra cover, I am not the first to post the SLV idea in this forum.  SLV was actually written up on VIC once before back in December 2010 by carbone959 at $28.  Carbone’s timing wasn’t bad, because SLV hit a high of $47 in April 2011 (the spot price of silver hit an all-time high of $48.64 per ounce on April 29th) and didn’t fall below $30 until the spring of 2013.  You needed to get out pretty quick after that, though, because SLV started dropping with the rest of the commodity sector and fell below $15 by late 2016.  

I have mostly sworn off investing in natural resource / commodity related stocks (see my Prosafe recommendation as Exhibit A), but I do have a question written on my white board here in the office that sometimes helps me identify where value might be in the markets. 

The question is this:  Where is there obvious pain and distress in the market today?   If it takes me more than 10 seconds to think of the answer, it’s not obvious enough for me to do anything and I go back to my regularly scheduled programming of looking for undervalued stocks.  In late 2015 the answer every day for about a month was “gold and silver” (and “oil and gas”) and I actually spent a little time looking at gold and silver miners until I gave up and realized that I don’t have an analytical model to value the stocks with any conviction.  I looked at royalty companies (where I’ve done OK in a small sample size in the past) but none looked really cheap.  So I decided to just buy some SLV call options, and I was pretty surprised at how cheap the options were given the very volatile underlying metal price.   I’d actually bought little option positions like this in the past just to satisfy myself that I’d taken some action on whatever the answer to my “distress” question was when I wasn’t able to figure out anything else.  In any case, I still like the SLV call options today and still own some.  Silver and gold are not in any obvious distress today, but they are still relatively unpopular after the brutal commodity sell-off of the last couple of years and could surprise. 

OK, why silver and not some other metal?  Again, I’m going to give you the disclaimer that I’m not a gold / silver bug and I normally try not to discuss religion, politics, or precious metals.  But for some reason I’ve found I have an affinity for silver within the context of buying call options for a couple of reasons.

First of all, silver is much more volatile than gold, and the current SLV price in the mid-$17 (spot price of silver today is $18 and change) is pretty far from the recent year highs.  Silver traded well into the 30s and 40s between late early 2011 and early 2013.  Because I don’t have any material commodity / natural resource exposure elsewhere in the fund, I want my small call option position to really work if precious metals do catch a big move here.  I’d encourage you to look at a 7 year chart of silver to give you an idea of how much this commodity can move.

Secondly, I keep looking at the supply/demand data available at the Silver Institute website that shows industrial and investment demand outstripping mine production every year (not sure about the validity of the data given the industry affiliation, but here is the link for whatever weight one wishes to assign to it).

Third, all the reasons people own gold apply to silver, but silver production doesn’t usually respond to large increases in demand immediately because most silver production comes as a by-product from base metal mines (or so I learned from reading silver investment materials).  Gold and silver both sold off pretty hard on the Trump rally in late 2016, and while silver is starting to recover it could go much higher given the right circumstances.

So, here’s the math on the call options.  I’m going to use the October calls for this particular example, and I’m going to use a slightly in-the-money contract because I like options that have some intrinsic value.  With SLV at $17.35, I can buy the October $16 calls for $2.20.   The underlying SLV stock has to rise 4.9% for me to break even on the contract, but has to decline 7.8% for me to lose my entire premium. 

This contract buys 235 days of time value.  If silver goes to $20 and I hold to the expiry date, I will make roughly 80% on my option, or 16 bps on a 20bp call position.  If SLV goes to $22.50, my 20 bps turns into 60 bps (40 bps profit), and if SLV goes to $25, I get a 3-to-1 payoff and my 20 bps is now 80 bps (60 bps of profit on a 20bps exposure).  

I’m not counting on a repeat of the “commodity super cycle” move here in 2017, so I’ll stop there.  By the way, I have generally used a 20 bps cash starter position size and then will average down once if my timing turns out to be poor on ideas like this where I am going more or less on sentiment and don’t have an intrinsic value calculation to guide my entry and exit.  

The option above is just given for the sake of example, one can obviously choose a different strike price or expiration date depending on your view (or lack thereof) regarding timing and magnitude of any move.  Personally, I like going out about six months at a stretch and I like being a bit in the money, since I don't have strong views about timing or magnitude - just want a little bit of exposure.


I’m sure many of you have looked at / contemplated / actually done some “tail” hedge positions at some point.  I think SLV can be thought of in those terms, but with the convenience of daily liquidity and pretty simple scenario analysis.   I have compared SLV options to buying options on other securities, and I am often surprised because the options don’t appear to me to reflect the full historical volatility of silver, perhaps because recent day to day volatility for both silver and gold has been pretty muted.  That’s about it.  To those of you who made it this far, thanks for your open-mindedness and apologies to those of you who find this write-up too far from the value spectrum to qualify.   I will try to get something more in line with the traditional fare on the site at the next available opportunity. 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.


Precious metals move higher in 2017 than people expect

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