We are well aware of the massive importance of the $1500 - $1530 support level for gold and the $26 support level for silver. COTs and sentiment continue to suggest that these support levels will hold, but if they donít there could be a bloodbath, caused by the large number of stops clustered beneath being triggered, and if there is we are not going to be caught napping. Letís take a quick look at the longer-term charts for gold and silver to remind ourselves why these support levels are so important Ė see below the next paragraph.
While it is perfectly in order to go aggressively long here, because of the favorable COTs, especially for silver, and the rotten sentiment which is typical of a bottom, and the highly favorable risk/reward ratio on account support being so well defined, we are not blind to what could happen if these support levels fail, and Big Money is doubtless aware that if it can succeed in pushing gold and silver down through these support levels it could trigger an avalanche of liquidation as the mass of stops beneath the support are triggered Ė this would enable them to have a field day mopping up PM sector investments on the cheap Ė even cheaper than they are now.
Fortunately we are aware of this possible game, and know the correct strategy to avoid us becoming a victim of it, and more than that to actually benefit from it. The normal defensive tactic is to employ stops beneath the support, but this is not entirely satisfactory as it carries the risk of being shaken out of positions by a breakdown that proves to be false. A much better tactic for those who are able to implement it, is to buy the sector here, but instead of employing stops, to buy tranches of cheap out of the money Puts to protect positions. This way you donít have to relinquish your holdings if the support fails, as the options can be purchased in sufficient quantity to afford point for point protection. The more crafty among you can load up on some dirt cheap lower strikes, and make a killing if gold and silver crash the support and plunge, over and above the protection of the value of your long positions. We have already detailed these defensive strategies in the article If Gold $1500 and Silver $26 Should Fail and this update is intended to serve as a timely reminder, and also to bring to your attention a refinement of our options strategy with regards to silver, using ZSL Calls in preference to SLV Puts as set out below. If you have already bought some SLV Puts, they should serve the purpose almost as well.
One final important point, which has been realized in recent days. iShares Silver Trust SLV options are substantially less liquid than Proshares Ultrashort Silver ZSL options. What this means is that spreads on the latter are narrower. Therefore it is better to do ZSL Calls than SLV Puts. We have traded ZSL Call options on several occasions in the past on silver plunges and made spectacular gains, and we know from experience that the trick is to cash them in ahead of the turn - in other words when silver is plunging and downside momentum is high, they should ideally be ditched ahead of silver slowing down and turning. This is easy to say and hard to do, but we have done this a couple of times and avoided losing our profits.
None of the above implies that we believe that gold and silver are going to crash their respective support levels, what it does mean is that if they do we are prepared and are not going to caught out.
Posted at 11.45 am EDT on 11th April 13.