Silver Arbitrage Opportunity

 |  Includes: CEF, PSLV, SIVR, SLV
by: Todd Johnson

Sprott Physical Silver Trust (NYSEARCA:PSLV) represents a 21.6% arbitrage opportunity for investors. As of October 18th, Sprott Physical Silver Trust (PSLV) closed at $15.17. The Sprott Physical Silver Trust's Net Asset Value (NAV) is $12.46. This indicates Sprott Physical Silver Trust is trading at a 21.75% premium to NAV. The shares are backed by 100% silver bullion.

Trade Actions

Silver bullion should not trade at a 20% premium to net asset value. The arbitrage goal is to profit on the Sprott Physical Silver Trust's 21.75% premium to NAV. This action requires one short-position and one long-position. Here is an example of my proposed trade:

1. Short 400-shares Sprott Physical Silver Trust (PSLV). The shares closed at $15.17. This will be a $6,068 credit to my account. The net asset value is overvalued by [$6,068 - $4,984 NAV = $1,084] $1,084.

2. Buy 200-shares of iShares Silver Trust ((NYSEARCA:SLV)). The shares closed at $31.33. This is a debit of $6,266. This is almost an even trade dollar-for-dollar against the short position.

ETFS Physical Silver Shares (NYSEARCA:SIVR) is another equity to invest in for exposure to silver bullion. Central Fund of Canada Limited (NYSEMKT:CEF) would be an option except the fund holds not only silver bullion but also gold bullion in Canadian bank vaults. I am choosing to go long SLV because they have the largest market cap of approximately $10-billion.

3. The trade will have an out-of-pocket expense of [$6,266 - $6,068 = $198] $198. I am short 400-PSLV shares and long 200-SLV shares. The catalyst is a PSLV secondary offering. Depending upon the size of the secondary, the net effect should immediately bring down the Sprott share net asset value.

Trade Premise & Rationale

Due to the significant premium to NAV, approximately 800,000-PSLV shares are short as of early October.

Eric Sprott has sold insider Sprott Physical Silver Trust shares in recent months. The rationale is due to the NAV's premium. I confirmed this with Sprott personnel. I confirmed this feedback in this article: "Sprott Insiders Are Selling PSLV And So Should You". Sprott Asset Management earns approximately 45-basis points for PSLV annual expense fees. The more assets under management, the more fees to Sprott Asset Management. Sprott has a vested interest to offer a secondary offering of PSLV shares to the market.

Per my telephone conversation with Sprott personnel, a secondary offering cannot occur until November 1st, 2011. This is 1-year after the IPO. This date is less than 2-weeks away.

Trade Goals

I fully expect a PSLV secondary offering. I recognize the secondary cannot occur until November 1st or later. The secondary price will be close to fair market value of silver bullion. This will result in the currently outstanding trust shares to decrease in price. My long position in SLV is not trading at a premium and should retain its value compared to the NAV compression in the Sprott shares. When the premium to NAV decreases, I plan to close the net trade.

Disclosure: I am short PSLV. I am long SLV and CEF.