Back in August, Seeking Alpha contributors Andrew McElroy and Hubert Moolman offered contrasting takes on silver. Mooman saw silver spiking higher, and McElroy saw it topping. We know now who was right (congratulations, Mr. McElroy), but at the time we weren't sure. So we suggested that silver bulls hedge their bets by hedging the iShares Silver Trust ETF (NYSEARCA:SLV). Since then, the ETF is down 20%, following a 4.7% drop on Thursday.
Let's update how that hedge has reacted to SLV's drop and then consider where it might go from here.
The August 11th Optimal Collar Hedge:
As of August 11th's close, this was the optimal collar to hedge 600 shares of SLV against a greater-than-13% drop by the end of March while not capping an investor's upside at less than 16% by the end of that time period (screen captures via the Portfolio Armor iOS app).
As you can see at the bottom of the second screen capture above, the cost was negative, so an investor would have collected an amount equal to $90, or 0.47% of position value when opening this collar (calculated conservatively, using the ask price of the puts and the bid price of the calls).
The idea behind this hedge was that the investor could tolerate a decline of 13% but no more than that. Let's see where you'd be had you hedged then and held through Thursday's drop.
How The August 11th Collar Responded To SLV's Drop
Here's an updated quote on the put leg as of Thursday's close:
And here is an updated quote on the call leg:
How That Hedge Ameliorated SLV's Drop
SLV closed at $18.96 on Thursday, August 11th. A shareholder who owned 600 shares of it and hedged with the collar above then had $11,376 in SLV shares plus $740 in puts, and if he wanted to buy-to-close his short call leg, he would have needed to pay $830 to do that. So, his net position value on August 11th was ($11,376 + $740) - $830 = $11,286.
SLV closed at $15.18 on Thursday, December 15th, down 20% from its closing price on August 11th. The investor's shares were worth $9,108 as of 12/15, his put options were worth $1,254, and if he wanted to close out the short call leg of his collar, it would have cost him $27, using the midpoint of the spread, in both cases. So: ($9,108 + $1,254) - $27 = $10,335. $10,335 represents an 8.4% drop from $11,286.
More Protection Than Promised
So, although SLV had dropped by about 20% at the time of the calculations above, and the investor's hedge was designed to limit him to a loss of no more than 13%, he was actually down 8.4% on his combined net hedge plus underlying stock position by this point. As with Intuitive Surgical (NASDAQ:ISRG) earlier this week, this is another example of the impact of time value on a hedge designed to protect based on its intrinsic value alone.
What Next For SLV?
To get sense of that in the short term, we pulled up SLV's chart on Squeeze Metrics (we have an affiliate partnership with them, and are compensated if a reader joins the site).
DPI, or Dark Pool Indicator, you may recall, is a measure of whether institutions are net buyers or sellers of the security in private exchanges, away from the public markets. From December 8th until Tuesday, institutions were net sellers of SLV in dark pools, but on Wednesday the DPI swung into bullish territory at 52%, and, as you can see highlighted at the top left of the chart above, the DPI rose to 57% on Thursday.
So, as SLV was tanking on Thursday, dark pool investors were turning slightly more bullish on it. The other interesting figure in that chart is the GEX, or Gamma Exposure, of -281,518 shares. That's the number of shares option market makers would have to buy back if SLV were to rise 1%, and it's represented by the reddish-yellow line in the chart. The negative GEX is a short-term bullish indicator here as well.
Whether or not SLV bounces in the near term, if you're hedged with the collar above, it doesn't expire until March, so you have time to feel this out, while your downside is strictly limited. You might consider buying-to-close the call leg of the collar (for pennies per contract) to eliminate your upside cap.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.