Friday, August 17, 2018

anatomy of silver gold pair trade

Gold is a monetary metal, i. e. gold is money. Gold can be used as a safe storage of value when fiat currencies are being devalued day by day. Also, rising gold price usually means that faith in banking and governmental institutions is falling and investors are looking for safe haven. Gold has few industrial uses.
Silver is used both as a monetary and industrial asset. Consequently, there is the strong silver-gold correlation.  However, because silver also has many industrial uses it is affected by the business cycle. 
A trader can try to profit form the interplay of monetary and industrial factors. From historical perspective Silver/Gold ratio is rather high,  i.e ~ 80 : 

One /SI contract is a digital equivalent of 5,000 oz of silver. At the moment it can be hedged with ~ 62 oz of gold. 

One /GC contract is a digital equivalent of 100 oz of gold.  60 delta /GC call against  /SI contract gives a fully hedged position.

Naturally, a contrarian wants to short gold and long silver here but let us think some fundamentals first. 

 1. Physical investment (coins, et cetera)  is depressed  ( negative ).
 2. Industrial demand is rising  (positive).
 3. Rising interest rates  (negative).

Eventually, 2 will change 1 into positive and a new secular bull market will be born. However, 3 provides a very strong negative pressure and prices like $10 per oz may happen first. In this case, the proposed trading strategy is: 

accumulate long silver while hedging the position with gold calls until rate environment remains negative.

 The factors that favor this strategy are:

 1.  High Silver/Gold ratio;
 2.  Theta decay in gold calls;
 3.  Increasing industrial demand for silver.
 4.  Long-term devaluation of $USD. 

4/27/18 Here is the entry where silver was  lightly underhedged:

Exec Time Spread Side Qty Pos Effect Symbol Exp Strike Type Price Net Price Order Type
4/27/2018 11:12 SINGLE SELL -1 TO OPEN /GCM8 1/100 JUN 18 /OGM8 1330 CALL 10.6 10.6 LMT
4/27/2018 11:10 FUTURE BUY 1 TO OPEN /SIN8 18-Jul FUTURE 16.52 16.52 LMT

If the gold price is on a move /GC delta has to be updated accordingly.

PM complex moved down.  -40 /GC delta of the original trade became -20. Posted is the trade which made /GC delta back to -40.

Exec TimeSpreadSideQtyPos EffectSymbolExpStrikeTypePriceNet PriceOrder Type
5/1/2018 10:52SINGLEBUY1TO CLOSE/GCM8 1/100 JUN 18/OGM81330CALL4.64.6LMT
5/1/2018 10:49SINGLESELL-1TO OPEN/GCQ8 1/100 JUL 18/OGN81325CALL14.114.1LMT

 For chart lovers I have a graphical representation of the trade:

Today (5/2/18) after FED meeting the silver-gold pair trade went positive.   It is nothing wrong if one wants to take  ~$300 and run.  However, I want to l keep the trade open for now.

Flat. The trade generated $600 profit before commissions.  /GC hedge and  Silver/Gold ratio played out to my expectation.

Exec Time Spread Side Qty Pos Effect Symbol Exp Strike Type Price Net Price Order Type
5/9/2018 8:54 FUTURE SELL -1 TO CLOSE /SIN8 18-Jul FUTURE 16.55 16.55 LMT
5/9/2018 8:32 SINGLE BUY 1 TO CLOSE /GCQ8 1/100 JUL 18 /OGN8 1325 CALL 15.6 15.6 LMT

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