Silver Prices and Options Expiration

Here's what we covered… 

  • Review of the where we are in the series 
  • What are options?
  • Life options versus financial options 
  • Options and derivatives
  • Who writes the majority of options?
  • Options Leverage
  • OTC options
  • Incentive for expiring out of the money and their influence on price.
  • The set up for silver price volatility around options expiration 
  • Commercial shorts versus managed money traders.
  • Being prepared for options expiration, and what you can do.

This is episode number 6 in this series where we are discussing what's really influencing prices right now versus what will ultimately become the manifestation of the fundamental reality.

We've been doing these deep dives over the last five weeks. The first week, we stayed shallow and light on the issues. I introduced most of the concepts. We'll do a recap today, but before we get started, I want you to please type your name and where you're from in the chat box either to the write or below depending on how you're viewing this or where you're viewing it from. Again, just use your keyboard, type in your name and where you're from so that I can connect with you.

Today's topic is silver prices and options expiration. It's somewhat timely and that we're seeing a certain amount of market volatility. I don't think it's necessarily related to options expiration this week, although this week was an option's expiration. The FOMC meeting probably had more to do with what we're seeing right now in terms of the market action. 

As a recap, we've been going through these factors that I think are the key to peace of mind if you're trade oriented in any way. If you wanted to look for a time to buy or a time to just hold out and wait for the markets settle its stuff out. These are the real keys that are influencing price, not fundamental supply and demand, yet not deflation or inflation. It's the way that the trading occurs. We've been talking about a bunch of factors. We started with HFT and algorithm training. We went on the technical analysis, standard of care.

We've discussed data releases. We have not yet discussed FOMC, I skipped over that. I realized when I'm preparing for this, but we're going to discuss options expiration today and then next week. Then the week after we'll discuss management of perception economics, and trading patterns that are unique to precious metals. 

I think that the primary influences that a COMEX or the futures market and that's where we see this interaction between high frequency traders represented by the commercial, the big commercial traders. Everyone's an algorithm trader, but the relationship between the commercial banks and the manage money traders or what give advice to the primary price discovery process. We talked about high frequency trading in general. It's just it's an evolution because there are no regulators anymore. It's algorithm trading gone wrong.

The way that that interaction takes place is centered around technical analysis. We've discussed silver prices and technical analysis in the previous episode, but basically it's a forecasting method that uses price and volume. It's become like a religion. Moving averages are really the key. There is relative strength indicators, which are important, but not as important as moving averages. Specifically, the 50-day moving out within a 200-day moving average and later on I'll show you each one about where we are in terms of that picture.

The key is that technical analysis is based on this principle that price reflects really all relative information. That leads to the standard of care in trading. It's a fiduciary obligation gone wrong and that you can ignore fundamental analysis if you're a trader and just focus on technical analysis because that's what everybody else is doing. It leaves an opening for the influence of behavioral economic. This management of perception economics that causes a collective blindness.

Most of the trading community is completely detached from the underlying reality, which recruit makes it more likely that when we do return the reality, it will come with a force that none of us can really imagine. Last week, we discussed the influence of these, of some correlations on data releases and price action. Mainly, the CPI and the unemployment data windows reports come out depending on the structure of the traders, on COMEX at that particular time. We can very likely see some volatility. It also happens to be that CPI and unemployment are tied to the Fed's forward guidance tool. 

It's a tool that they're using. They've run out of tools, but this is the latest. QE didn't work. Lowering interest rates to zero percent didn't work. Maybe negative interest rates? That probably won't work either. But forward guidance is the latest tool that uses CPI and unemployment, which also makes it another derivative factor that makes it more likely. When we see those releases, if the trading structure is setup that way, that we will see a downturn in price.

That leads us to the topic of today, "Silver prices and option expiration." 

If you just backup and look at it, options are everywhere, there are life options and there are financial options. Life options could be as simple as ... some of them are free, many of them are free. If I choose not to ride my motorcycle in rush hour traffic, that's pretty cheap free option that has potentially the high upside of me not putting myself in danger of an accident or getting killed.

Similarly, the surf today is pumping. It's 30-feet out there today and I have the choice. When this is over I might decide to paddle out and put myself in that particular situation or in danger. Or I could just say, "I'm going to skip that. I'll do some other exercise. And avoid the risk of drowning." 

In finance, there is a price associated with options. Options are contracts or derivatives. A futures contract is also a derivative.

For this particular discussion, we're talking about options associated with silver futures contracts. Options are these contracts that give the buyer the right but not the obligation to take possession of the underlying asset. It could be any security asset, or in this case a commodity. 

Options are characterized by a few things and I'll discuss each one of them, but there's high leverage. They're opaque, and many are over the counter. And for the most part, they're written by big banks. 

The leverage with options is what really makes them so flexible and popular as a instrument for trading. 

With a futures contract, let's say a silver contract on the COMEX is 5,000-ounces, that's $75,000 to buy outright. You can take control of that contract and  the margin requirement is somewhere between $9- 10,000 right now. 

The options, the futures option would be a $1,000, so it's much less initial price, you can control the same contract and that makes them very attractive. Now in general, they're pretty opaque, opaque in terms of what you can see in volume. There isn't the same amount of data that comes out around positioning, who they are, you don't know who they are in the futures market either, but in terms of overall volume or trade setup or structure, you don't get that kind of data like you do with futures contracts.

Many options are traded over the counter meaning there is no clearing house between them. They could be setup between private entities instead of having a clearing house to clear them. The big one, the big takeaway and the reason why it's so important to present I think here is that they're written by the big banks. That means that inherently, there is a built-in incentive to have these options that they've written expire out of the money. At the end of each month, we have this options expiration. 

If you look back in time and you look at the price and you look at this time of the month, now some months are much more important than others. For example, the December options expiration is typically much more important. There's a lot more movement around the price at that point. If the setup, and I'll talk more about this and show you where we are, to illustrate this even further. 

If the setup is conducive for a downturn, that options expiration can be the excuse that these traders, the high frequency traders that can put the price wherever they want to pull the trigger, put the price below and moving average, let's say the 200-day moving average which is just happening or just happened. The right around the options expiration, the price will move down. Most of the options that were written expire out of the money. The big banks collect this premium, they make money, it's just another way to rig the market, but another excuse, another mechanism for making a profit.

The reason why again, this is just one other factor, it's a correlation and I know that correlations don't necessarily mean causation or causality and correlation are always tied together, but it's enough of one given a certain setup, given where we are in the cycle and the relationship between the commercial net short position and the relative position of the manage money traders or the trading category, the speculative trading category. 

Depending on where we are in that cycle, these data releases, this option expiration, the FOMC meeting can have a significant, usually negative impact on price. Therefore, if you know what's coming ahead of time, you can either be prepared so that when it happens you can keep your head about you or that it retains some peace of mind as we go through this torture. If you're inclined, like I said before if you're a trader or if you're just an accumulator and you're looking for opportunities to save a little on premium or the dollar cost average or premiums out over time, you can find these little entry points or places where it's better just to stay back and see where we go before making a purchase or going in and making a buy.

Dr. Jeff Lewis is the publisher and editor, of He recently created a forum called the, a community of like-minded individuals active in the silver market. He also runs a private membership program called the Lewis Mariani Silver Letters.

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