Silver stocks puts

Is Now a Good Time to Sell Puts on Silver Stocks?

Silver stocks traded lower this week thanks to a shift in expectations.

The pullback really got started last week when minutes from the last Fed meeting were released. The minutes painted a picture of a deeply divided Federal Reserve Board. Some members are in favor of raising interest rates to ward off inflation. And some members are opposed because higher rates could hurt the economy.

Honestly, I’m sick and tired of the soap opera of whether the Fed will — or will not — raise rates.

But as an income investor, it’s important for you to be aware of the current interest rate expectations, and how those expectations affect your investments.

Why Gold and Silver Stocks Traded Lower

To understand why gold and silver stocks traded lower this week, we need to connect the dots between the U.S. economy, interest rates, the U.S. dollar, and precious metal prices.

The U.S. economy looks stronger these days. The most recent Fed minutes referenced the strong employment market. This week’s housing data also hinted at a stronger economic picture with demand for homes picking up.

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Fed members are more likely to hike rates this year if the economy is strong. Higher rates help to fight the possibility of inflation. Plus, higher rates would also benefit a large portion of the U.S. population who need higher yields for their savings.

Following the Fed minutes last week and the housing data this week, the chance of a rate hike this year now looks much more likely. In fact, futures are now pointing to more than a 50% probability of a hike this year.

Rate Hike Probability

An increase in rates should drive the U.S. dollar higher. That’s because in zero (or negative) interest rate world, a currency that offers a yield will be more popular. If rates are higher in the U.S., demand for dollars (which pay higher yields) will increase.

The more demand for dollars, the higher the value of the U.S. dollar compared to other currencies.

Now if the dollar trades higher, it will take fewer dollars to buy an ounce of gold or silver. In other words, the price (in dollars) of gold and silver will drop.

Lower gold and silver prices could cut into mining companies’ profits and that’s what is causing silver stocks to drop.

Lower Stocks Means Higher Put Premiums

One of the good things about declining stock prices is that we can capture more income from selling put contracts.

Remember, when we sell a put contract, we’re entering an agreement to buy shares of stock at an agreed upon price. We receive income from entering these agreements. And the agreements give us a chance to buy shares at a discount.

When silver stocks are trading lower, the income we can receive from selling put contracts increases. That’s because traders are more fearful, and are willing to pay more to buy option contracts. (Traders often buy put contracts as insurance in case silver stocks trade lower.)

Now that silver stocks are trading lower, you’ll receive more income from selling these put contracts. Plus, you can agree to buy shares at an even lower price, helping to reduce your risk.

Why Silver Stocks Should Ultimately Trade Higher

Silver stocks are lower right now because investors expect higher interest rates and a stronger U.S. dollar. We’ve already covered why these forces pressure gold and silver stocks.

But you should also keep in mind that gold and silver stocks often do well during times of uncertainty.

If traditional stocks trade lower, investors will be looking for places to invest their money that protect the value of their investments. Traditionally, gold and silver investments have been great for protecting the value of your wealth.

Safe stocks are expensive right now and could trade lower. If these stocks start losing value, conservative investors could quickly shift gears and protect their wealth by investing in gold and silver. This demand for precious metals should send gold and silver stocks higher.

It’s helpful to note that the major trend for gold and silver stocks has turned higher. And the recent pullback for gold and silver stocks could be short lived.

If higher interest rates cause dividend stocks to trade lower, gold and silver stocks could trade higher. And if expectations for higher interest rates don’t materialize, this could also be bullish for gold and silver stocks. At this point, the probability of gold and silver stocks continuing their bullish trend is very good.

Keep in mind, silver prices are typically more volatile than gold prices. So silver stocks may give us more value both because of higher put prices and also because silver stocks could rebound more quickly.

Three Silver Stocks For Selling Puts

Here are three silver stocks that could be great candidates for our put selling strategy:

Silver Standard Resources (SSRI). SSRI operates precious metals mines in North and South America. Management expects to generate between 200,000 and 210,000 ounces of silver this year, and Wall Street analysts expect the company to generate earnings per share of $0.81 this year.

The stock has been trending higher this year, but the most recent pullback gives us a chance to sell puts for more income, with a lower strike price. This should help to minimize the risk for your income trade.

SSRI Chart

Silver Wheaton Corp. (SLW). SLW is a “precious metals streaming company.” Instead of owning physical mines, SLW owns royalty agreements with a number of precious metal miners. These agreements allow SLW to buy ounces of silver cheaply, and then sell the ounces at a higher price.

The higher silver trades, the more profit SLW can generate. That’s why shares of SLW have been trending higher this year (as the price of silver has increased). The current pullback should be a great opportunity to set up a new income trade.

SLW Chart 2016-08-25

iShares Silver Trust (SLV). While SLV isn’t technically a “silver stock” (it’s classified as an ETF), this is still a great put selling candidate.

SLV trades higher and lower based on the actual price of silver. So as silver has pulled back over the past week, this gives us a chance to set up an income trade with a lower strike price. That should leave you with less risk than if you sold puts when silver was hitting a new 52-week high.

SLV chart

There are a number of different put contracts you could sell for each candidate. The specific contract is up to you — depending on how much time you’re willing to be in the trade, and how aggressive or conservative you want to be.

Here’s to growing your income!

Zach Scheidt