Tim Bovee, Private Trader: SLV: A shorter-term bull play

Update 2/18/2015: Silver moved my bull position decisively into the unprofitable range on Tuesday, Feb. 17, and I closed the position the next day for a loss.

The share price declined by 9.1% over 29 days, or a 115% annual rate. My optons position produced a 226.1% loss on debit, for a 2,846% annual rate.

The silver exchange-traded fund SLV broke above its 20-day price channel on Friday, just prior to the three-day weekend marking the birth of Dr. Martin Luther King Jr.

I like the funds based on commodities -- the metals and fossil fuels. The gold of GLD, the silver of SLV, the oil of USO and the natural gas of UNG provide a way to diversify from the stocks that are the rice bowl of my trade.

Everything that is traded is hearing the drumbeat of the economy. The commodities, though, seem to march to the tune of a somewhat different drummer.

But as always, it is the chart that counts.

The Chart

The five-year chart on the left vividly illustrates that the bull signal from SLV is a counter-trend rally. I trade with the trend. End of story.

Or maybe not. One thing I've learned from my recent crash-course in volatility plays keyed to earnings announcements is the importance of focusing on the the appropriate degree in assessing a trend.

Click on chart to enlarge.

SLV 5 years weekly bars (left), 30 days hourly bars (right)

The present near-term uptrend began in late December and so has a history. Is it possible to construct a trade that would conceivable make some money over the next few weeks under my Volatility Rules?

The price movements on the 30-day chart to the right are quite messy, as is often the case at the lower degrees. It defies my skills at Elliott wave analysis.

The sharp rise on Jan. 16, which I've marked on the chart, looks like a 3rd wave of some sort, just because of the energy it is showing. If that is indeed the case, then it suggests that there is room to the upside.

The most recent leg of the prior downtrend began in July 2014, and so far the present rise has corrected to the 38.2% Fibonacci retracement level. A 50% retracement to $17.64 or a 61.8% retracement to $18.35 isn't out of the question.

Volatility

The problem with a volatility play on an exchange-traded fund is that there is no trigger for a collapse of implied volatility. Things can simply hang on forever. Because of that lack of a motivator, I want to have a somewhat longer trade than I would otherwise.

The other factor, of course, is that the trade must be structured as a short vertical options spread, sold for a credit and expiring sooner rather than later.

To meet those needs, I shall trade the FEB series of monthly options, which expire in 31 days, on Feb. 21.

A third criterion is that implied volatility must be relatively high, in the 60th percentile or greater of the rise to the most recent peak, and should be giving signals that it's upward run is nearing exhaustion.

SLV's implied volatility stands at 37%, in the 82nd percentile of its rise from 13% on Sept. 5, 2014 to the peak of 41% on Nov. 16, 2014.

It has since the peak attempted other upward moves three times, each producing a lower high. This is classic topping behavior.

If SLV's rise continues, normal behavior will be for implied volatility to continue its decline.

Ranges implied by options and the chart

Week	SD1 68.2%	SD2 95%	Chart
Upper	18.00	20.80	20.64
Lower	15.37	13.56	14.64
Gain/loss	10.5%	21.1%

Implied volatility 1 and 2 standard deviations; chart support and resistance
The Trade

The trend is up and so I will structure this as a bull put options spread.

Bull put spread, short the $16.50 puts and long the $15.50 puts
sold for a credit and expiring Feb. 21
Probability of expiring out-of-the-money

FEB	Strike	%
	16.5	64.5

Decision for My Account

I've opened a bull position in SLV, as described above.

The risk/reward ratio stands at 67:20 (3.35:1).

I'll be fine if the price does indeed rise as I expect. However, the options grid didn't allow for much in the way of a cushion of profit in case the price falls. Protecting the ranges would have required a larger risk/reward ratio than I like. I could have lowered the ratio, but only at the ost of a lower chance of the position expiring out of the money for maximum profit.

I shall have to be very alert in case of a reversal.

-- Tim Bovee, Portland, Oregon, Jan. 20, 2015

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References

My volatility trading rules can be read here. For a discussion of the rationale behind the rules, see my essay, "Rules for very short term trades".

From time to time I use the number 68.2% in using applied volatility to calculate the expected trading range. This comes from statistics and refers to the one standard deviation boundaries, which are expected to contain 68.2% of whatever is being studied. Putting it another way, given an item (a trade or whatever), there is a 68.2% chance that it will appear within those boundaries.

My method of scoring price and volatility responses to earnings, used in the "Chart" section, is the simplest imaginable. Looking at the four most recent earnings announcements, I give one point for a rising price or rising volatility in the week after the announcement, subtract a point to a falling price or volatility, and give a zero if the response is sideways movement. I then add the four quarters together to produce separate scores for price and volatility, and then add the two to produce a combined score.

Disclaimer

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.

No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decisions for his or her own account, and take responsibility for the consequences.