Precious metals hit new multiyear lows early this month, when a better-than-expected employment report pushed stocks higher. But a bottom looks to be in place, as SPDR Gold Shares (NYSE: GLD) rallied nearly 4% since its Oct. 3 low.
At these discounted levels, I think silver looks like an even better value. Silver prices peaked in 2011, just below their record high of $50 an ounce, which was set in 1980. The iShares Silver Trust (NYSE: SLV) now sits more than 65% off its 2011 highs.
Prior to its break to new lows in early October, SLV traded in a range from $18 to $21 for nearly a year. It broke down through $18 support in mid-September, but the recent price lows did not come on new highs in volatility. This represents a bullish divergence and could be a sign SLV has bottomed.
A move back inside the channel targets a move to resistance at $21. This level is also the midpoint of a multiyear channel.
The $21 target is about 26% higher than recent prices, but traders who use a capital-preserving, stock substitution strategy could almost double their money on a move to that level.
One major advantage of using a long call option rather than buying a stock outright is putting up much less capital to control 100 shares -- that's the power of leverage. But with all of the potential strike and expiration combinations, choosing an option can be a daunting task.
You want to buy a high-probability option that has enough time to be right, so there are two rules traders should follow:
Rule One: Choose a call option with a delta of 70 or above.
An option's strike price is the level at which the options buyer has the right to purchase the underlying stock or ETF without any obligation to do so. (In reality, you rarely convert the option into shares, but rather simply sell back the option you bought to exit the trade for a gain or loss.)
It is important to buy options that pay off from a modest price move in the underlying stock or ETF rather than those that only make money on the infrequent price explosion. In-the-money options are more expensive, but they're worth it, as your chances of success are mathematically superior to buying cheap, out-of-the-money options that rarely pay off.
The options Greek delta approximates the odds that an option will be in the money at expiration. It is a measurement of how well an option follows the movement in the underlying security. You can find an option's delta using an options calculator, such as the one offered by the CBOE.
With SLV trading near $16.70 at the time of this writing, an in-the-money $14 strike call option currently has about $2.70 in real or intrinsic value. The remainder of the premium is the time value of the option. And this call option has a delta of about 78.
Rule Two: Buy more time until expiration than you may need -- at least three to six months -- for the trade to develop.
Time is an investor's greatest asset when you have completely limited the exposure risks. Traders often do not buy enough time for the trade to achieve profitable results. Nothing is more frustrating than being right about a move only after the option has expired.
With these rules in mind, I recommend the SLV Jan 2016 14 Calls at $3.75 or less.
A close below $15 in SLV on a weekly basis or the loss of half of the options premium would trigger an exit. If you do not use a stop, the maximum loss is still limited to the $375 or less paid per option contract. The upside, on the other hand, is unlimited. And the January 2016 options give the bull trend a year and three months to develop.
This trade breaks even at $17.75 ($14 strike plus $3.75 options premium). That is about $1 above SLV's recent price. If shares hit the $21 target, then the call option would have $7 of intrinsic value and deliver a gain of nearly 90%.
Recommended Trade Setup:
-- Buy SLV Jan 2016 14 Calls at $3.75 or less
-- Set stop-loss at $1.87
-- Set initial price target at $7 for a potential 87% gain in 15 months
Note: There's another call option strategy that lets you earn $1,200 or more each month from the stocks you already own -- by "renting" them out to other investors. To learn about this easy process, click here.
This article originally appeared on ProfitableTrading.com: A $375 Bet on This Discounted Precious Metal Could Make You 87%