Silver Options Explained



Silver OptionsSilver options are option contracts in which the underlying asset is not silver per se but a silver futures contract.

The holder of a silver option possesses the right but not the obligation to buy the underlying futures contract at the strike price upon expiry. Like securities options this option will cease to exist once the option expires.

Where are Silver Options Traded?

Silver options are traded on the New York Mercantile Exchange (NYMEX).

NYMEX Silver option prices are quoted in dollars and cents per ounce and their underlying futures are traded in lots of 5000 troy ounces of silver.

Call and Put Options

Silver options are available in either calls or puts, if you expect the price of silver to rise you’d buy call options and if you expect the price to fall you’d buy put options.

You don’t have to limit yourself to buying calls and puts on their own however, you can combine them together to create more complex strategies known as spreads.

How to Trade Silver Options

Let’s assume that Silver is trading at a price of $11.30 per troy ounce. A NYMEX Silver call option with the same expiration month and a strike price of $11.00 is being priced at $0.7500/oz. Since each underlying NYMEX Silver futures contract represents 5000 troy ounces of silver, the premium you need to pay to own the call option is USD 3,750.

Assuming that by option expiration day, the price of the underlying silver futures has risen by 15% and is now trading at USD 12.99 per troy ounce. Your call option is now what’s known as in the money (ITM).

By exercising your call option now, you get to assume a long position in the underlying silver futures at the strike price of $11.00. This means that you get to buy the underlying silver at only $11.00/oz on delivery day.

To realize any profit from the trade you need to enter an offsetting short futures position for one contract of the underlying silver futures at the market price of $12.99 per troy ounce, resulting in a profit of $1.9900/oz. Since each NYMEX Silver call option covers 5000 troy ounces of silver, your gross profit from the long call position is $9,950. After deducting the initial options premium of $3,750 that you paid to buy the call option, your net profit for the trade will be $6,200.

In reality there’s no need to exercise the call option to realize your profit. You can simply close out the position by selling the call option back to the market. This is how 95% of options contracts are closed.

The above example doesn’t include any broker commissions. In the real world you’ll have to pay commission to your broker every time you execute a trade. These commissions are usually very small and shouldn’t affect your profit too much.

Silver Options vs. Silver Futures

You might be thinking, what’s the point of buying an options contract when you can just buy the underlying futures contract instead? Well there are distinct advantages to buying options over futures contracts. We’ve outlined a few of the major ones below.

1. Additional Leverage

You’d gain additional leverage buying a silver options contract compared to taking an open position on the underlying silver futures outright, since the premium payable is typically much lower than the margin requirement needed to open a position in the underlying silver futures.

2. Limit Potential Losses

Since silver options only grant the right but not the obligation to assume the underlying silver futures position, potential losses are limited to the option premium paid to purchase the option in the first place.

3. Flexibility

Options carry way more flexibility than using futures alone, you can easily combine different options to create complex spread strategies that are both more profitable and have higher risk reward ratios.

Conclusion

With the economy the way it is Silver is a good bet. You might have thought that silver trading was beyond you, but as you can see trading Silver options isn’t anymore difficult than trading securities options.

The only obstacle to trading Silver might be your broker not being able to oblige. Fortunately this is easily fixed by signing up for an account at optionsXpress who offer Silver options and futures through their standard platform.




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