Endeavor Silver: A Lower Risk Play on Silver Volatility

| About: Endeavour Silver (EXK)

Has COMEX silver peaked? Is the latest firestorm a correction or price reversal? When will the COMEX raise the margin requirement again? Will the price of silver ETF's like SLV disconnect from the price of the physical metal? Do the ETF's really have the physical metal they claim? Is silver really money, or just a shiny industrial metal? Will physical silver trade at 20.00 before it trades at 100.00 ... or the other way around?

Professional traders don't really care. They figure out ways to make money if silver goes up or down; and they do it by effectively assessing and controlling their risk. Of course, there are no risk free trades. Having your capital tied up in anything these days carries risk ... got dollars?

For those who can't wait to dive (back) into the metal mania, we've structured some reasonable trades identifying promising mining companies that take advantage of high option implied volatility, permitting us to maintain a presence in an otherwise higher risk environment. We prefer low cost producing miners to explorers (although we own some explorers) ... companies with no, or low debt that have solid growth prospects. We also favor companies that are operating in reasonably safe political regions.

We think that Endeavor Silver Corp. (NYSE:EXK) fits the bill in the present market environment. At its website, EXK states that its strategic goal is to become a 5 – 10 million ounce per year silver producer within two years. It has increased production every year since its first year of production; and it produced 3.3 million ounces in 2010. Its mines are operated in Mexico, it has no debt and it has reduced its cash cost of production in each of the last three years. In short, it is a growing, well run company.

Coincidentally, option implied volatility (IV) for EXK is presently high. We like to take advantage of high option IV to lower our effective entry point for stock purchases, reduce and better control our risk of loss, and enhance profitability. We find that using options as a tool in conjunction with stock purchases adds staying power in uncertain times. Several months ago we identified a similar situation in U. S. Gold (NYSE:UXG) and the trade is working in accordance with our plan.

So how can we enter the treacherous silver market, control our risk and turn volatility to our advantage? You might consider this:

  1. Buy EXK stock at 9.00 or better;
  2. Sell 1 November EXK 7.50 put for every 100 shares of EXK stock purchased; and
  3. Sell 1 November EXK 12.50 call for a combined 2.50 in total premium.

If additional EXK stock is assigned to us in November through the put sales our overall break even point for the trade is 7.00 per share. We see strong Fibonacci and chart support for EXK on both candlestick and point and figure charts at 7.00. If the stock price falls, but not below 7.50, our break even point is 6.50. We welcome the opportunity to own EXK shares between 6.50 – 7.00 per share.

On the other hand, if silver is resurrected and takes EXK along for the ride, the maximum profit would be 6.00 on a 16.50 investment, or 72% annualized if the stock is called away in November. Of course, by covering the position with overhead calls we limit the maximum profitability of the trade. However, the potential reward is more than acceptable in return for the ability to control our risk over the course of the trade.

Disclosure: I am long EXK.

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Tagged: , , Silver, Canada, Options
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