The precious metals complex has been in a steady downtrend ever since early July. Besides the generally weak price action, what has been most concerning to me from a technical standpoint is the relative weakness in silver, which is now testing a multiyear low that has held for the past 18 months:
Unfortunately for precious metals bulls, this support is looking more and more tenuous as sellers keep taking it back there after a series of smaller bounces since last summer. The silver/gold ratio has not made a new low, but is also quite close:
Part of the weakness in silver and gold has been the general selling going on the commodity sector, which is likely somewhat related to broad dollar strength since July. However, the inability of gold and silver to stage much of a bounce when the geopolitical backdrop since July has been quite heated is not encouraging. New buyers don’t seem to be plentiful, even when concerning global headlines hit.
Put all of it together, and if you made me guess the next 10% move in silver, I would say lower. However, I don’t have much conviction, and silver is already down more than 10% in the past 2 months, so the entry here right at support is hardly a good one. Though some traders might say that a convincing break of support here might be the spot to short, I am less enthusiastic about that type of trade given the risk of a false breakdown and the historically volatile nature of silver near technical inflection points.
As opposed to a directional trade, there is a trade structure in the options market that looks interesting to me.
Implied volatility in silver has not bounced much even as the commodity tests support:[caption id="attachment_45305" align="aligncenter" width="600"] 30 day implied volatility in SLV, courtesy of Bloomberg[/caption]
Implied volatility is still below 20, mainly since silver has reached support on a slow grind lower over the past couple of months. Yet, I would expect realized volatility to pick up here – either silver breaks down to a new low on heavy selling, or the commodity bounces once again from support, possibly leading to a bigger move higher given the tight nature of the recent price action.
With that in mind, a 3 month straddle, such as the Dec 18 straddle, is priced quite cheaply in my view. It costs about $1.41 at the moment, implying a break-even of $16.59 on the downside or $19.41 on the upside by December expiration. Given that expiration is more than 3 months away, I like my odds of capturing a 10%+ move in either direction between now and then.
As for risk management, if I did this trade, I would probably give the trade a month, and get out for a 20-30% loss from time decay if SLV did not move by mid-October. If it did make a 10%+ move on a breakdown or bounce off of support, that’s when I would look to sell for a 50-100% gain. At the moment, I’m not putting the trade on, but this is on my radar.