If you listened to Money Morning's recent special report from global resources expert Peter Krauth, you know the long-term outlook for silver is decidedly positive.
Soaring investment demand, continued industrial use, a growing supply shortage, and falling ore quality all signal a sharply bullish outlook for the "poor man's precious metal."
So, how can you position yourself to profit from silver's coming advance without exposing yourself to the excessive risk?
One way is to use options – either on silver futures contracts or shares of silver-related stocks and exchange-traded funds (ETFs) – in a strategy that strictly defines and limits your risk while still offering short-term returns of 100% or more.
Silver Options: How to Create a Bull Call Spread
Known as a "bull call spread," this technique involves simultaneously buying and selling two call options with the same underlying security and expiration date, but with differing strike prices.
Typically, a bull call spread involves buying an at- or slightly in-the-money call option – one with a strike price very near the current price of the underlying asset – and simultaneously selling an out-of-the-money call option with a strike price several increments above the current security price.
The difference between the two strike prices is referred to as the "spread."
To illustrate, let's look at an example using options on silver futures, which are traded in the CME Group's Comex division. In this case, one futures options contract represents 5,000 ounces of silver.
To create your bull call spread, you would purchase the slightly in-the-money July $33.00 call, quoted at $3.451 an ounce ($17,255), and simultaneously sell the out-of-the-money July $35.00 call at a price of $2.572 an ounce ($12,860).
The net cost of this spread is 87.9 cents an ounce ($3.451 – $2.572 = $0.879), or $4,395. That is also your maximum possible loss on the trade should the July silver future stand below $33.00 when the options expire on June 26, 2012.
What's more, the spread trade breaks even at a July silver futures price of just $33.879 as opposed to the break-even price of $36.451 had you merely purchased the $33.00 call alone.
So, what's the catch?
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