World Link Futures, Inc.

Investing in Gold and Silver

Have you been watching the price of gold and silver? Both of these metals (see charts at right) have captured the attention of many investors, including those who have never before traded commodities. Whether you believe that prices will continue to rise, or will decline to more historically typical levels, commodity futures and options provide a way to speculate in these markets. Unfortunately, the increased volatility accompanying the higher price levels of gold and silver has made buying and selling a traditional futures contract too expensive for many investors. For example, to buy or sell one COMEX® gold contract requires $2,700 in margin while a COMEX silver contract requires $5,400 in margin. (Source: NYMEX. Values are as of Jan 18, 2007.*) Higher implied volatilies have, in turn, inflated option premiums as well, making considerable the cost of a simple put or call option purchase. How then can the beginner who wishes to limit risk or the average investor with only modest risk capital participate in these markets?

Low-Risk Investment Strategies

Investors who desire to trade gold and silver but who want to reduce the risk and cost of traditional futures have two basic strategies:

  • Trade mini-sized contracts. The Chicago Board of Trade (CBOT®) lists mini-sized futures contracts in gold and silver that are significantly less risky and, correspondingly, less expensive than their COMEX counterparts. Investors can trade direction by simply buying or selling futures contracts. For more information, please see the box at right.

  • Trade option spreads. When the price of a call or put option is considered to be too expensive, an investor can instead buy an option spread. The two types of option spreads of interest are the Bull Call Spread, bought when prices are expected to rally, and the Bear Put Spread, bought when prices are expected to fall. Each of these spreads is constructed by simultaneously buying one option and selling another. The option sold helps to offset the cost of the option purchased, thus making the trade more affordable - even when implied volatilities are high. In return, though, maximum gain is limited. Even so, these option spreads can generate impressive percentage returns while at the same time limiting the downside risk to a known and fixed amount.

    Bull Call and Bear Put Spreads are extremely versatile: By varying the strike prices, an investor can construct a spread that has the cost and pay-out structure most beneficial given their price expectations. For more information, please see, "Gold & Silver Option Spread Strategies" at right. These option spread examples utilize contracts that trade on the COMEX since the CBOT does not currently list options on their mini-sized gold and silver futures contracts.

    Constructing "Double-or-Nothing" Trades

    Option spreads enable the investor to construct trade scenarios that resemble the typical double-or-nothing bet. If the investor believes that prices will rally, then a Bull Call Spread can be purchased. For example, with COMEX April gold futures at $634.20 (as of Jan 18, 2007), an investor can buy the 640/650 Bull Call Spread for $330 plus slippage, commission and fees, say $400 in total. If April gold futures is trading at $650 or higher when the options expire in April, then this spread will be worth its maximum of $1,000 - or a little more than double the purchase price. If, however, gold is trading below $640, then the investor will lose all of the investment. But this is the most that can be lost. So, the trade is double or nothing.

    The same type of trade can be constructed if prices are expected to decline. In this case, the investor will will buy a Bear Put Spread. For more information, please see, "Gold & Silver Option Spread Strategies" at right.

    Buyer Beware

    The phenomenal rise in gold and silver - many investors may have forgotten that gold languished beneathe the $300 level in 2001 while silver was under $5 per ounce - has been fueled in no small part by investor perceptions and expectations. (See "What's Driving Gold and Silver Prices" at right.) Perceptions and expectations can change quickly - especially among speculators - leading to rapid selling. Consequently, gold prices can collapse suddenly and without warning. For this reason, the low-risk strategies described above, especially the option spread trades, are a good idea not just for the beginner but even for the more experienced trader.

    The silver market provides a good example of the type of price collapse that can happen when perceptions and expectations change. On Dec 15, 2006, silver closed down almost $1 relative to the previous day, representing a dollar value change of about $5,000 per contract - arguably a 5-fold increase in what historically had been regarded as a big move in silver. This is the main reason why margin values for silver quoted above are so much higher than for gold - and another reason why an investor should focus on low-risk strategies when trading this market.


    Gold and Silver

    What's Driving Gold Prices?
    What's Driving Silver Prices?

  • Gold & Silver Investor's Pack

    COMEX GOLD Futures Price
    COMEX SILVER Futures Price

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    CBOT mini-sized Gold & Silver Futures Contracts
    Gold and Silver
    Small Contract Size
    Extended Trading Hours
    Reduced Margin Requirements
    Profit/Loss Calculations

    Low-Cost, Low-Risk
    Gold & Silver Option
    Spread Strategies
    Bull Call Spread
    How Does it Work?
    Gold Spread Example
    Silver Spread Example
    Bear Put Spread
    How Does it Work?
    Gold Spread Example
    Silver Spread Example


    Gold & Silver Resources

    CBOT Mini-sized Gold chart
    CBOT Mini-sized Silver chart
    COMEX Gold Option Prices
    COMEX Silver Option Prices

    Your next step...

    After reading the information in this Gold and Silver Investor Center, your next step should be to request a free Gold & Silver Investor's Pack. Loaded with brochures written by industry professionals, this Investor's Pack will move from the basic to the more advanced option strategies, including the Bull Call Spread and the Bear Put Spread discussed above. You may also want to request free access to the Learning Curve. There you will find more coverage on option-related issues such as: Which Option to Buy?, Understanding Option Prices, as well as a very good article on bull call and bear put spreads called, "Option Spreads: Putting the Odds in Your Favor". And don't forget to take a look at the recommended books below.

    Ready to take the next step? Then speak to a commodities professional at Alaron. They'll help you decide if trading gold and silver is right for you and can discuss some of the opportunities provided by these exciting metal markets. Alaron has some of the industry's top leading analysts in the precious metals markets.

    Recommended Reading...
    The Power of Gold: The History of an Obsession The Abcs Of Gold Investing: How To Protect And Build Your Wealth With Gold Bull and Bear Spreads: Advanced Option Strategies for Any Market Option Spreads Made Easy (audio CD)

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    * Margins can and do change. Consult the Exchange or your broker for current margins.

    CBOT is a registered trademark of the Board of Trade of the City of Chicago, Inc.

    COMEX is a division of the New York Mercantile Exchange.

    THE RISK OF LOSS IN TRADING COMMODITY CONTRACTS CAN BE SUBSTANTIAL.
    YOU SHOULD, THEREFORE, CAREFULLY CONSIDER WHETHER SUCH TRADING IS
    SUITABLE FOR YOU IN LIGHT OF YOUR FINANCIAL CONDITION. FUTURES, FOREX
    AND OPTIONS TRADING ARE NOT SUITABLE FOR EVERYONE.

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