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:
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.
 
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Small Contract Size Extended Trading Hours Reduced Margin Requirements Profit/Loss Calculations
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Gold & Silver Option Spread Strategies | |
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Gold Spread Example Silver Spread Example |
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Gold Spread Example Silver Spread Example |
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CBOT Mini-sized Gold chart |
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...
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