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Silver Prices: An Option Trading Strategy That Tells You When to Buy

As last week's Money Morning special report pointed out, the long-term fundamentals for silver prices are decidedly bullish.

However, in today's volatile market, picking the right time to buy silver is something of a guessing game.

But if you are familiar with options, you can let them be your guide in learning precisely when to buy.

And here's the best part: This option trading strategy will only cost you a few dollars.

It works with either options on silver futures - e.g., the standard 5,000-ounce Comex contract, recently valued at around $140,000 - or any of the much more affordable silver-based exchange-traded funds (ETFs) on which options trade.

Taking the Guesswork Out of Silver Prices

For ease of explanation, I'll base our example on the iShares Silver Trust ETF (NYSEArca: SLV), recently priced at $27.34. For comparison purposes, the price of a single SLV share typically tracks the price of one ounce of silver, but is usually 75 to 80 cents lower.

Here's what you do:

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How to Use Options to Hedge Against a Stock Market Correction

Stocks have been mostly higher the past five months, with the Dow Jones Industrial Average recently topping 13,000 for a few days and the Nasdaq Composite touching the key 3,000 mark on the final day of February.

However, the markets have turned erratic the last week or so, and big moves like last Tuesday's plunge have left many investors to worry about a looming stock market correction.

Normally, that would send options-savvy investors in search of protective puts so they could lock in profits on their long stock positions.

In doing so they essentially are buying an "insurance policy" that would pay off should prices indeed turn lower in the next couple of months.

But, as readers who checked out Money Morning writer Don Miller's Wednesday article on the VIX Indicator, which measures trading activity in options on the Standard &Poor's 500 index - and, by association, options on individual stocks comprising the major indices - last week's jump in volatility sent put prices sharply higher.

In fact, the VIX Indicator itself jumped from just 16.83 on Feb. 23 to a reading of 20.84 on Tuesday.

And, though it has pulled back a bit since, the volatility means merely buying protective puts at this time would be a fairly costly proposition.

As an example, assume you hold 100 shares of stock in Las Vegas Sands Corp. (NYSE: LVS), having happily watched as the market's rally carried its price from an Oct. 3, 2011, level of $36.71 to a March 1 high of $56.82.

However, the $3.33 decline by LVS last Monday and Tuesday leaves you little doubt the stock would be vulnerable in any upcoming stock market correction.

And even though the stock rebounded to $55.29 by Thursday's close, you still feel like you need a little protection for your paper profits.

So, what do you do?

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Stock Options: The Profit Strategy Behind an Oft-Overlooked Investment Tool

Stock options are a valuable tool for any investor who wants to increase income, maximize returns and better control risks in his or her stock portfolio. They can be used alone, in combination with other options, or paired with their underlying securities.

Yet few investors make an effort to use - or even understand - options strategies, despite their benefits.

If you're among this group of reluctant option traders, it's probably because you're a victim of what I call "The Options Myth," which goes something like this:

"Options aren't for you. Only really sophisticated and experienced investors should consider options. With options, it's all or nothing; you can lose your entire investment. At least with a good stock you know it's not going to zero. If you're wrong, you've always got a chance for a comeback because you still own something!"

This mantra is chanted to clients by literally thousands of financial professionals around the world - "advisors" who either don't understand options themselves or view them exclusively as ultra-high-risk. Some mainstream brokerage firms - Edward Jones, for example - even refuse to let their account holders trade them.

But the truth is that options really can be for you - and they should be, whether you're a go-for-the-gold speculator, an average investor looking to hedge your portfolio against market pullbacks, or a retiree seeking to get a little extra cash flow from your dividend-paying shares.

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