Low-Risk Options Plays On Gold And Silver

Includes: DGSE, GDX, GLD, SLV
by: Larry Meyers

Trading the precious metals has been a frustrating experience, unless you have a quick trigger finger and a crystal ball. The volatility of the metals has rendered trading a difficult task and technical analysis has not provided much assistance. For those thinking about a long-term core long or short position, you are stuck with the ultimate dilemma: Are the metals moving higher or lower in the long-term, and how can you be sure you're calling it right?

Precious metals don't have earnings estimates. With stocks, you can take a stab at a reasonable valuation. Commodities have no such predictive elements. Fortunately, options can help capture modest returns in the metals without exposing you to the kind of risk an unhedged position does. Here are several ways to play the precious metals for the year ahead:

The SPDR Gold Trust (NYSEARCA:GLD) allows you to purchase baskets of gold, so it makes a perfect proxy for the yellow metal. As of this writing, it trades at $161.22. I suggest selling a naked January 2013 140 put for $6.50. This allows you to collect a $650 premium per contract while providing you substantial protection in case gold should crater. Should gold do just that, you'll get a warning first -- there is important support right at $1,500. After that, if GLD breaks down to that $140 strike price this year, you then short it. This allows you protect the premium you collected and offsets any loss you may experience if the stock is put to you.

What if you don't want to miss out if gold prices skyrocket? Sell a naked call. Again, I suggest one that is well out of the money, such as the January 2013 190 Call for $7.00. Once again, you lock in your $700 premium and buy the stock to limit your loss if the stock hits $190.

There's nothing wrong with selling these naked options closer to the money and collect the higher premiums. The issue is that if you have to buy or short the underlying stock to protect yourself from losses, you may find yourself in another conundrum -- when to close the position. It's no problem if, say, you get GLD put to you at $140 but you also shorted the stock at the same time. You can close them both out at any time. But if you jump the gun and short GLD before it hits $140, and the stock is not put to you after all, and GLD goes back up, you're holding a short position you don't want to be holding.

If you would prefer even less volatility in your trade, then shift over to the Market Vectors Gold Mining ETF (NYSEARCA:GDX), which is one step removed from holding the metal itself. The ETF price range over the past two years has been between 45 and 65, and presently trades right at $52. So I'd sell the naked January 2013 40 Put for $2.45, and the January 2013 65 Call for $2.82, again keeping an eye out to short or buy as circumstances warrant.

Finally, you could just buy DGSE Companies (NYSEMKT:DGSE), which I wrote about recently. As the only public retail bullion trading company, and one that is expanding rapidly, it's a great way to buy into gold without buying gold.

Let's extend this strategy to silver. The iShares Silver Trust (NYSEARCA:SLV) is a very liquid vehicle with which to purchase silver. Silver is struggling technically, so I'd look to sell the naked January 2013 25 put, since $25 is where the long term support line is, and sell it for $2.70, with intent to short the ETF at $25. Silver would break through resistance at $35, so I'd sell the naked January 2013 35 Call for $2.95, with intent to buy SLV at $35.

Disclosure: I am long DGSE.