SLV Setup and the AMC Aftermath

How it works, and a potential next move:

Everyone’s heard of the crazy stock moves in GME, AMC, and other names by now, but most people have no idea how that works. I’m going to illustrate that with what looks to be the next one: SLV.

Here’s how it works:

  • One option contract gives you the right to purchase 100 shares of stock at a given “strike” price before a given expiration date. The price is listed per share, so a price of $1.02 means 1 contract for 100 shares would cost $102.
  • When you purchase an option contract, the dealer who sells it is effectively short the stock when the price rises.
  • The dealer sells these all day every day with the idea of making a premium without taking market risk. To do this, he uses a sophisticated method called “gamma hedging.”
  • When the stock price rises past the strike price, the dealer needs to purchase the shares in order to ensure that he can hand them over at option expiration.
  • If the stock rises past the strike price + the premium paid for the call option, then the dealer quickly starts to lose money.
  • The “premium”, or price that the option contract sells for, is lower the closer the option gets to expiration. (look in the “last price” column for this)

The basic idea is that these people are forcing the dealer to purchase 1 share at full price for the per-share premium, so if you load up on the $25 strike at $1.00 price, then the dealer has to put in $25 in shares for every $1 that you put in.

The dealer will not purchase the shares until they approach the strike price, however, so like a rocket it can take a lot of fuel to start moving and then quickly gain momentum.

If this trade is truly being targeted for this type of move, then you should see these out-of-the-money Feb 5th options contracts selling like crazy when the markets open on Monday. I fully expect it to be targeted because of the way those call volumes are spread. The $35 strike hitting in 5 days would be nearly impossible without this momentum build, but 30,092 contracts traded Friday. If you look at any other expirations, the volumes are tiny in comparison.

Note that there is no guarantee that this will work. You could have shares dumped on the market by a big fund or it could fail to get momentum and launch. If you want to play this however, these are your options:

  1. Safest bet: Purchase SLV shares and sell out-of-the money covered calls on them. You’ll collect a hefty premium for these calls if people are spam-buying them. This ensures that you’ll make money if it’s flat, and if it drops then those premiums help offset your losses.
  2. Neutral: Purchase SLV shares and hold them. You’re betting they go up, and I’d say the odds are probably in your favor if people are pumping the stock.
  3. High risk: Purchase some of these call options. If it takes off you win big, if it fizzles out you’ll probably lose everything.

My experience with AMC

I just figured out what these guys were doing and how this worked last weekend. Thinking back, it’s pretty clear this happened all summer, possibly starting with Tesla. On Sunday night I couldn’t sleep because I was so excited about a possible move in AMC.

Monday morning, options contracts that expired in 4 days duration were moving like crazy, and the premiums were getting hefty. I’m used to looking at premiums to determine whether to sell covered calls, so I immediately started buying shares in blocks of 1,000 and then selling covered calls in blocks of 10.

The price was $4.50/share and I initially started selling the a contract for $0.70 with a strike price of $5.50. I was thinking if it ends up flat, I make $0.70/$4.50 over just 4 days which is a 15.6% move! Even better, if it launched I could get up to $1.70/$5.50 which is a 37.8% move! I did a number of those and figured it was enough.

Then the premiums got so hefty that a $7 strike price was giving me $0.70 per share and they were at $4.60 each – so a bought a couple thousand more and sold those, which allowed me a max gain of $7.70/$4.60 = 67.4%.

On Tuesday, the price didn’t seem to be moving much. Then after hours, the stock exploded higher. I never expected it could go up close to $20 per share in just 2 days. I was totally stoked about a max gain, but mentally kicking myself for selling those covered calls. When I logged in to my Ameritrade account though, I noticed a warning about restricted trading in a number of names including AMC. That spooked me a bit so I closed out most of my shares by purchasing back the call options and selling them on the market. After the crazy news and talk of further restrictions, I decided to close out the rest Thursday morning, but they were already called … and then it occured to me that I should have just let it be. I gave back all that call premium by selling those things to unwind the trade, when the holders of those calls were in a much more precarious position. All in all I ended up with a great gain, a bit under 50%.

End of week trades, portfolio, and final note

With the crazy news this week, work being busy, and driving in mid-week (2 hours each way, ugh), I didn’t do much trading outside of that. On Friday I purchased another TLT call – going for a deep in the money Jan 2023 expiration. I’ve certainly heard plenty about liquidity problems and the rickety market structure to make me nervous.

I also sold off some of my SLV calls today because it shot up a bunch so it seemed like a good time to de-risk … and of course it was before I found that SLV was a potential target. I also did a typical lay-up trade, purchasing shares of CCJ near the previous multi-year resistance (now support) and selling 2-week at the money covered calls on it which will lock me in a 5% gain in 2 weeks if nothing happens. CCJ is one of the stocks on my list to accumulate a bunch of when the market corrects, so I’m not too worried about holding it.

Here’s where my portfolio ended up:

    • 23.6% Gold Miner Stocks, Large
    • 14.3% Gold Miner Calls, Large
    • 11.9% EQX (small gold miner stock)
    • 2.0% PVG Calls (small gold miner)
    • 2.0% SAND Calls (small gold streamer)
    • 5.9% SLV Calls (silver ETF)
    • 7.0% TLT Calls
    • 9.8% IWM Puts
    • 2.6% EEM Puts
    • 0.6% CCJ Calls
    • 2.3% CCJ w/ covered calls sold
    • 0.7% Crypto
    • 17.4% Unallocated cash

If you compare to last week, you’ll see my allocations went down on a number of things. The crazy thing is I wasn’t selling, it’s just diluted from the results this week.

Here’s my plans for Monday morning: I’m going into the market about 30 minutes after open to see if there are SLV contracts flying out like crazy. If there are, then I’ll be buying a lot of shares. I am pretty risk-averse, so I won’t be participating in the lottery ticket contracts … and I might even sell covered calls on it, but this time I’d sell really deep out of the money.

Here are a couple of few warnings to consider with this trade:

  1. SLV has a market cap of $14.8 B compared to a market cap of $1.5 B for AMC last Monday, so it will take a lot more buying to make it move.
  2. SLV has a short interest around 10% of float, compared to AMC last week around 60%. The short squeeze potential isn’t nearly as big.
  3. SLV will likely issue shares to buy physical Silver with. That’s what they do to track silver, and it means that significant share price appreciation would require the whole silver market to move.

On the positive side, silver is considered to be cheap compared to gold, SLV currently (as of Friday close) trades at a slight discount to it’s underlying silver, and the amount of money that’s being poured into the options market should tilt the risk to the upside. As such, I highly recommend that you purchase SLV shares and maybe even sell covered calls to take advantage of an elevated premium in covered calls that expire next Friday. Purchasing those 4-day covered calls is like buying a lottery ticket.

Final note – If you look at the markets Monday and no one is buying Feb 5th out-of-the-money covered calls in SLV, then don’t bother with the trade.

May the odds be ever in your favor!

About johnonstocks

I've been trading stocks since 2003, active on Motley Fool's discussion boards and using first Hidden Gems, then Global Gains. I no longer have the newsletters, but I keep up on the WSJ and read David Rosenberg everyday at Education: CFA level 2 candidate MBA-focus in Finance, Marshall, University of Southern California - expected Dec 2010. BS Mechanical Engineering, UC San Diego, June 2002
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