Gold and silver options and ETNs

October 31, 2014 07:00 PM

Two markets based on the same underlying commodities give traders in gold and silver options and exchange-traded notes (ETNs) more information than would be available from a single market. Price trends and relative changes over time for ETNs can be used to guide trading in associated options, while variations in options pricing suggest possible trades in ETNs. 

The market that both options and ETNs depend on for pricing is the futures market. This link provides a strong, timely and dependable flow of information that should be valuable for traders in either or both ETN and options markets.

One key assumption is that changes over time in prices for an ETN and a single futures contract are virtually identical. “Virtually” is the operative  word here, because the changes are not completely equal, but equal enough so trades may be based on either an ETN or related futures contract with a high degree of confidence. It is possible to create spread trades without knowing the precise formulas behind the ETN price quotes.

The close fit between price movements of ETNs and futures is shown on “Futures and ETNs” (below). The charts cover the period from January to July 1, 2014, and include December 2014 futures contracts on the two metals and unleveraged ETNs: UGB for gold and USV for silver (E-TRACS CMC Gold and Silver TR ETN).

As expected from past history, silver futures and ETNs are more volatile than similar securities based on gold. The period during June 2014, when silver fluctuated from -6% cumulative percentage price change to 8% compared with gold’s cumulative percentage change from 2% to 8%, is a reminder of prices in June through September 2012, when silver futures and ETN fluctuated from -15% to 10% while gold futures and ETN changed from approximately 0% to 10%.

Based on historical norms, the price swings of silver around gold can indicate potential spread trading opportunities in either ETNs or futures. For example, from June 13 to June 30, 2014, silver USV gained $3.56, from $26.69 to $28.86, while gold UBG increased by $1.33, from $33.31 to $34.64; a net gain of $2.33.

A similar spread using December 2014 futures contracts had silver gaining 1.465 from 19.751 on June 13 to 21.216 on June 30, or $7,325. Over the same period, gold futures increased by 47.9—from 1,274.9 to 1,322.8, or $4,790—a net gain of $2,535 from buying silver futures and shorting gold futures to hedge the trade.

“Spread for gold and silver calls” (below) describes a trade connected to the relatively large negative variation of silver futures and ETNs early in June 2014. Thus, the wide gap between price movements of gold and silver suggests the timing of a trade buying silver and selling gold—depending on a reversal in the gap to provide a hedged profit. Of the three strike prices considered for each metal, the 23 strike for silver and 1340 for gold are chosen because of the possibility of spreading two silver 23 strikes at a premium of $1,020 against a single 1340 strike for gold at a $2,060 premium. 

One concern in this trade is the potential for prices to turn down, with silver leading the way because of its inherent greater volatility. Of course, gold should decline as well, which would reduce the risk. In addition, the futures price for silver equals approximately 85% of the selected strike while gold’s December futures price is 95% of the 1340 strike. With gold futures further up the option price curve, as shown on “Spread for gold and silver calls” (below), the increased slope, or delta value, may help it overcome gold’s volatility disadvantage.

Comparative volatilities are displayed on the gold and silver call chart (see page 44). Gold options on June 13 and July 1 are much lower than the silver price curves, and show a slightly lower pattern for July 1 following the erosion of some time to expiration over the period June 13 through July 1. On the other hand, the silver prices (where each dot represents a strike price) increase a noticeable distance, temporarily ignoring the passage of time. 

Volatility & prices

The four options price curves carry information that is useful in trading futures and ETNs. The height of a price curve where the futures price equals a strike price is a measure of relative volatility. For example, on June 13, 2014, December gold and silver call price curves had heights of 3.57% and 5.31% (call prices as a percentage of strike prices that are equal to the respective futures prices, $1,274 and $19.75). It is not surprising that the percentages show that silver’s volatility is almost 50% larger than the implied volatility of gold.

The options markets continuously establish new upper and lower breakeven prices. These are prices of the underlying at expiration that would create zero gain or loss on a delta trade at today’s market prices, hedging a long futures contract with a number of sold call options determined by the inverse of the delta ratio.  

There is a separate set of breakeven prices associated with each strike price. For the options used in the call spread trade described earlier, silver strike 23 has upper and lower breakeven prices of $23.69 and $18.10, while the gold strike 1340 has breakeven prices of $1,395.19 and $1,203.26. The breakeven prices compared with current underlying futures prices are plus 20% and -8% for silver, and 9.4% and -5.6% for gold.

The upper and lower breakeven prices applied on a continuous basis by the options market represent an ongoing assessment of options traders regarding future price spreads. This information may be just as useful to the market for ETNs as it is for options and futures markets. Although the projections are in terms of plus and minus percentages with no indication of direction, they provide a trading tool that converts volatility measures into dollar spreads plus and minus from the current price.  

Risk in the silver-gold spread trade is relatively low because the same situation has occurred many times previously. The view of cumulative percentage price changes from April 21 to June 13 indicates that the trade might have been begun at several times during that period with varying degrees of success. The surge of silver vs. gold from June to July 1 implies that the market felt the moment had arrived to close the gap. 

The shadow knows

We have seen that silver cash and futures prices tend to follow the price movements of gold, which permits the occasional spread trade between the two metals to be effective. However, there is another factor at work when ETNs are introduced.

This is the shadow effect, meaning that ETNs are valued with respect to the underlying and must keep close to them in price. This effect can be observed on “Futures and ETNs,” where the ETN cumulative percentage prices tend to vary higher or lower than the underlying futures and then rebound. The tendency to follow the leader makes the ETN normally more volatile than the related futures contract.

It was stated earlier that ETNs and futures moved together so closely that overall the price changes were virtually identical, with the caveat that “virtually” means “the same for all practical purposes.” This leaves open the possibility of short-term, one-day, spread trades.

For example, on Feb. 13, 2014, cumulative percentage price changes for silver futures and the USV silver ETN are 3.619% and 0.367%, clearly out of line. On Feb. 14, the ETN rose 7.47% compared to a 5% increase for silver futures, and as shown on the chart the two series were once again overlapped.

Paul Cretien is an investment analyst and financial case writer. His e-mail is

About the Author

Paul Cretien is an investment analyst and financial case writer. His e-mail is