On November 10th of this year the margin requirement for those who speculate in silver futures was raised. The subsequent drop in the price of silver was attributed to the fact that many speculators had to liquidate a portion of their holdings to comply with the new margin requirements. Two days later, on November 12th, the central bank of China raised interest rates a half point. The price of silver swooned, justifying the increased margin requirements.
It's no secret to the relatively tiny silver investing community that the price of silver has been more volatile than the price of gold in recent months. On a percentage basis, it's not unusual for the daily price movement of silver to be two to three times as much as that of gold. That volatility increases the potential for gain, and the risk of loss, in the short term.
It's been many years since, as a novice, I lost my entire stake in the futures market. As I remember, a contract cost one percent of the value of silver represented by the contract. Now that's leverage. If you are trading on margin, the leverage is multiplied. On a day when the price of silver moves three to four percent, the speculator stands to make, or lose, 300% - 400% of the money required to buy the contract.
I like the leverage of futures contracts; but recent developments, first in the options market, and secondly, through specialized ETFs, provide enough leverage for me. I cannot watch my investments all day, or even check them hourly. However, my current silver investing spans a fairly broad spectrum, including shares of silver mining companies, an ETF, a leveraged ETF, and stock options on two of the three, and LEAPS on the other.
On November 12th, when the price of silver dropped precipitously, my account value took a multi-thousand dollar hit. I didn't lose any sleep over the ETFs, the mining stocks, or the LEAPS. I knew they'd come back in plenty of time. But I got a wakeup call with the stock options. Fortunately I had employed contingent trailing stops just the day before.
Options are a means of leveraging my investment choices, and I have traded stock options for years. But I was hesitant to buy options on silver mining companies and silver ETFs because of the very high premiums I had to pay. The premium is affected primarily by two factors; time until expiration, and volatility. If I pay a high premium, price of the underlying asset, whether stock or ETF, must move a good amount in the right direction just to break even.
If silver suffers through a multi-month pullback before returning to the price it was when I bought the options. I could lose a significant portion of my investment. That is because the time value of the option I bought has decreased with the passage of time. And no one can recover time lost. If, during the pullback and recovery, volatility decreases, option traders stand to lose even more. I am even rethinking my 2012 LEAPS. The 2013 I will let ride.
To reduce risk, stay away from options or short-term strategies. In the long run, I believe silver is as safe as gold, and will continue to outperform gold for reasons mentioned in other articles.
Learn how to protect yourself against the current (and impending) economic disaster with silver investing. For more information: http://www.esilverinvesting.com
