The securities trade could be further levered by purchasing the SLV shares on margin, but keeping the capital commitment to the $20,000 - $25,000 level would mean trading something less than two round-lots on the gold side. We'll forego additional leverage for now.
The futures position's higher downside variance also reflects leverage. The mean daily return for the futures position was 4.5 percent; on the securities side, it was 0.4 percent. Day-to-day futures losses, just like gains, were magnified. There were fewer days, too, in which losses were booked on the futures side—34 percent vs. 42 percent for the securities spread.
The reward-to-risk ratio measures the period return against the position's annualized volatility. Noting this, we can say that the futures trade may be four times riskier (measured by the size, but not the frequency, of day-to-day drawdowns), but that added risk is more than compensated by a leveraged return.
Unlevered Trades
Futures trades are not suitable for every investor. Neither is margin. Luckily, the gold/sliver ratio can be traded in a cash account with exchange-traded securities. The iShares SLV trust, for example, could have been purchased together with a position in the PowerShares DB Gold Short ETN (NYSE Arca: DGZ) in a 4-to-7 ratio. The DGZ note seeks to track the monthly performance of a single short gold futures contract.
For a capital outlay of $22,355 on Feb. 1, investors could obtain roughly equal dollar exposure to long silver and short gold. By April 12, the net position would have gained 16 percent with an annualized downside variance of 8.5 percent. The average daily return was 0.3 percent, though 38 percent of daily returns were losses.
Just because you can't use margin doesn't mean you can't enjoy leverage. You can double your dollars' effective shorting power by using the PowerShares DB Gold Double Short ETN (NYSE Arca: DZZ), which purports to offer two times the monthly short performance of gold futures.
With that leverage, $21,055 could have been divided between SLV and DZZ in a 5-to-8 ratio on Feb. 1, producing a 21.3 percent gain by April 12. Downside variance would have been clocked at 11.2 percent, with average daily gains of 0.4 percent.
Gold/Silver Ratio Spreads With ETNs
Table 2: SLV Trust With Gold ETNs
|
Trade |
Return |
Downside Variance |
Reward/ Risk |
Margin Required |
|
Long 400 SLV/ Long 700 DGZ |
16.0% |
8.5% |
1.00 |
No |
|
Long 500 SLV/ Long 800 DZZ |
21.3% |
11.2% |
1.02 |
No |
Conclusion
The clear standout among the four positions we've examined is the futures spread. Traders looking to get the most bang for their bucks when playing the gold/silver ratio—in either direction—would be better off using a commodity account if they can.
The proof's in the pictures.
If you liked this article, then check out:
- Metal Spreads Make More Money
- How To Play The Plunging Gold/Silver Ratio
- Gold/Silver Multiple At 37x. What Now?
