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Silver Wheaton Breaks Above 200-Day EMA

05/06/09 01:09:04 PM
by Donald W. Pendergast, Jr.

The precious metals sector has been holding its own lately; one of the key stocks to watch here is Silver Wheaton, which has just completed a very convincing bullish breakout.

Security:   SLW
Position:   Buy

Silver Wheaton (SLW) is one of the rising stars in the silver mining stock arena, and for good reason. Forward earnings estimates are projected to rise steadily through at least 2010 for this Canadian-based mining enterprise. Part of the reason for such favorable projections is due to the expectation for higher silver prices, but a greater part is due to the fact that Silver Wheaton is able to bring more silver (which it obtains from at least eight mines in six different countries -- Canada, Mexico, the United States, Sweden, Peru, and Greece) to market without incurring any substantial infrastructure expenses.

Currently, SLW's technicals are nothing less than outstanding, meriting a closer look by traders and investors who are seeking exposure to the long-term bull market in silver. Let's examine the daily chart for more details.

FIGURE 1: SLW, DAILY. Not only does SLW feature a series of bullish technicals, if the anticipated cross of the 50-day and 200-day EMAs to the upside (a golden cross) occurs, the bullish implications could be substantial.
Graphic provided by: MetaStock.
One glance at Figure 1 is all it takes on this one; this is a major bull market in progress, one that may soon be destined to further gains if a long-awaited golden cross takes place. The two moving averages plotted on the chart hold the key -- if the red 50-day exponential moving average (EMA) crosses above the blue 200-day EMA, a golden cross will have been completed. Institutional investors (the big mutual funds) will take special note of such an event and may be inclined to pour a great deal of additional capital into SLW, should that technically significant event actually occur.

Golden cross or not, the current chart configuration is especially bullish. The current uptrend is firmly established, price has just broken higher from a substantial pennant formation, the long-term accumulation/distribution line is bullish, the stock has successfully breached its 200-day EMA to the upside after several tests of support, the Aroon (14) trend intensity indicator has just swung to the bullish side of the fence, and, again, the stock has steadily higher earnings expectations for at least the next 19 months. The real question for SLW is this: How to play this setup with real money in order to make even more money?

Since option premiums for SLW aren't especially attractive right now (the implied volatility levels are relatively low), selling calls against existing stock positions isn't the wisest strategy here. However, for those who are firm believers in SLW's long-term prospects, here's an out-of-the-money backspread option play that might be of interest:

Sell 1 December $10 SLW call option
Buy 2 December $12.50 SLW call options

Net debit: approximately $0.20-0.25 per spread.

The big idea with a backspread is to latch onto a stock that is anticipated to have a substantial trending move in its near future, building an option position that is long more calls at a higher strike price ($12.50 in this case) than it is short a smaller number of calls at a lower ($10) strike price. Ideally, the short calls should be close to the current price of the underlying stock, but since SLW's current share price of $8.59 is midway between the $7.50 and $10 strikes, we'll opt for the higher strike for the short side of the position.

One advantage of a backspread is that timing isn't as important as it would be for a stock position; the sale of the short call also provides a bit of a buffer just in case the whole trade setup disintegrates, negating the hopes for the anticipated trend move. If the stock cooperates, beginning a sustained trend move, the long calls will begin to do their thing and carry the position, especially as their deltas go further in-the-money, far outpowering the loss on the short call part of the position.

Managing the backspread is fairly straightforward; some option pros suggest closing out a backspread when half of the potential time value has been used up, so since this is a seven-and-a-half month spread, closing it out by late August or early September might be a good idea, win or lose. The reason for the early closeout is to limit the maximum potential loss, which is always much higher if a losing backspread is held all the way through until expiration.

Looking at a couple of potential profit scenarios, if SLW is at $14 on or about August 27, 2009, and if implied volatility rises by 10 points, the spread would gain by approximately $138, a nearly seven-fold increase, not including commissions. Conversely, if SLW is at $7.00 on the same date and if implied volatility falls by 10 points, the spread will have incurred a loss of about $30. Maximum losses of about -$47 will occur if SLW is near $9.50 on August 27, 2009.

Overall, this out-of-the-money backspread offers a reasonable balance of risk to reward and could be a way for precious metals bulls to get in on further trending moves in Silver Wheaton shares.

Donald W. Pendergast, Jr.

Donald W. Pendergast is a financial markets consultant who offers specialized services to stock brokers and high net worth individuals who seek a better bottom line for their portfolios.

Title: Writer, market consultant
Company: Linear Trading Systems LLC
Jacksonville, FL 32217
Phone # for sales: 904-239-9564
E-mail address:

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