Why Silver Bugs Should Stock Up on ZSL Puts

Includes: PHYS, PSLV, SLV, ZSL
by: Galt's Gulch

Of the many ways to play the rise in silver, the safest remains buying pure physical silver coins/bars. However, that still isn’t the absolute most cost-efficient way, as explained in my other article, Why I'm Buying Puts on GLD - And Why You Should Too. Another variation of this strategy is buying put options on ZSL.

Facts about ZSL

  1. It is a 2x short silver ETF – if SLV rises 1%, ZSL falls 2%.

  2. ZSL is hurt by the compounding effect. It MUST trend down over time. If it started at $100, fell 50% one day (to $50) and rose 50% the next day, it would only be $75, not $100. Given time, it will probably hit $0.

  3. ZSL is too small for hedge funds or big players. Net assets are $128 million as of April 27, 2011. The big boys would move the market so much that it would become unprofitable.


If you believe (as I do) that silver will continue to rocket, as outlined in my other articles, I would propose buying both $4 and $8 strike price January 2012 puts.

Advantages vs. other vehicles:

  1. Safer than buying SLV outright (you don’t know if SLV is fully backed by silver but options are backed by the clearinghouse)

  2. Put options limit your losses compared to shorting ZSL – what if silver fell for a few days?

  3. Better risk/reward than almost all other vehicles.

  4. In a down market, it will reach $0 much faster than regular unlevered short positions!

Let me explain the last two points – let’s look at the the $4 strike, 2012 put. Currently, it is priced at $0.05 bid / $0.25 ask. If you assume that you buy on a down day for silver, you should be able to buy in at $0.15 on average. So, if ZSL goes to $1 in your time frame, you make 19X your money. But wait - because ZSL is levered, it will reach that $1 much faster than if you had bought calls on SLV (an equivalent position). Actually about 2X as fast. Put another way – you have 2X the time as compared to options on regular positions – but you still pay the same low price!

I suggest buying both $4 and $8 puts because the $4 puts I view as an “all or nothing” play, while the $8 puts are more realistic given the limited time (January 2012). There's also the leverage factor of ZSL: You could probably make a ton if silver rises to $75, for example, on the $8 puts, while the $4 puts would be profitable but not as much. Ultimately, which option you buy is up to you.

Finally, one may ask, why buy put options on derivative ETFs when you can get physical? The answer is simple. Today, $15 won’t get you one ounce of silver. But it can get you that $4 strike January 2012 put option. If that option’s value goes to $285, that implies that SLV has doubled from current levels (~$46) to $92. Meaning, at that point in time, you could STILL get three ounces of silver for 1/3 of an ounce today. In other words, if you play the options right and the economy doesn’t literally collapse immediately, you will have the time to get 9x the amount of physical silver LATER that you would with that $15 today!

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Disclosure: I am short GLD, ZSL. I have put options in both GLD and ZSL, as well as long positions in both gold and silver.