Silver Pairs Trade Delivering as Planned: More Room to Run?

Includes: PSLV, SLV
by: Everyday Finance

This week, I posted about a silver pairs trade strategy to exploit a clear market arbitrage opportunity whereby the premium on a silver closed-end fund had gotten out of hand. In essence, by shorting the physical-back closed-end fund (NYSEARCA:PSLV) and going long the silver ETF (NYSEARCA:SLV) at the same time with equivalent funds, you could capture the difference in premium that occurs over time with no net outflows, save for commissions. I thought it would be instructive to revisit the outcome after a short period of time.

At the time of posting, the premium on PSLV was approaching 24% and by the end of trading Friday, the premium was a mere 21.3% (Sprott's NAV page). Therefore, one would expect that this strategy would have delivered about an 2.7% return in just a few short days. A quick comparison of the two ETFs overlapped at any charting site like Google Finance across Thursday and Friday's action shows the two returns overlapping, with SLV down 0.22% and PSLV down 2.75%.

Since these both track silver, you'd think they'd trend together, right? Well, this is the premium compression on PSLV that I had predicted. See, as the premium dropped out, the performance of PSLV trailed the pure proxy SLV. See below how you would have fared had you undertaken the pairs trade suggested:

Example Silver Pairs Trade:

$10,000 Long SLV

-$10,000 Short PSLV

$0 Net Outflow

% Change PSLV -2.75%

% Change SLV -0.22%

Final PSLV Value (short): -$9725

Final SLV Value (long): $9978

Net Gain: $253

And of course, you can't calculate a percentage gain if you put no money down; that would be infinity. The beauty of the strategy is that the risk is minimized since you only lose money incrementally if the premium expands, the actual changes in spot price of silver over time don't matter, and there was no net outflow of cash required to execute (since your long and short positions were equivalent).

From here, there's likely some more room to run, but it wouldn't be out of the question for the premium to meander up into the mid-20s again. Last week was an optimal entry point and more will follow, just like when I employed the exact same strategy for this gold pairs trade last year with the comparative gold funds GLD (Gold ETF) and PHYS (Physical Gold Closed-End Fund). The one thing to be cognizant of though, is that the precious metals ETFs have varying tax implications depending on how the ETF is structured so make sure you understand the difference if you are tax-sensitive.

Disclosure: No current position in any ETFs or CEFs mentioned here. Shares were unavailable to short at time of writing.