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Silver Downtrend Strengthens

01/28/10 11:33:55 AM
by Donald W. Pendergast, Jr.

As silver approaches an important support area, traders begin to take sides for the ensuing battle.

Security:   SI, SLV
Position:   N/A

Silver has been falling steadily for the past couple of weeks, shedding about 12% of its value since mid-January. The disparity between the commercial and large speculator interests in the silver futures market has finally begun to resolve itself in favor of the big money commercials -- for now. With two significant support levels right below the current price, will this be enough to put a floor under this market and, if so, will it hold? Let's take a look at the daily chart of the continuous contract for COMEX silver futures.

FIGURE 1: SILVER, DAILY. Silver is rapidly closing in on its major support level at $16.15; a daily close below that price could set the stage for more selling down to the next Fibonacci 162% extension level near $15.39.
Graphic provided by: TradeStation.
Figure 1 is a very simple chart, one featuring several technical tools that can help us identify potential support levels as well as the strength of the recent downswing. Note the A-B labeling of the most recent swing termination points over which a Fibonacci extension ratio grid has been overlaid. The big idea here is that swing C has already exceeded 100% of the length of swing A-B and appears to be on track to move to at least the next Fibonacci ratio of 127%, a support level that also exactly coincides with the 200-day exponential moving average (EMA) at $16.15. This is a major support level, and any significant breach of it is very likely to unleash another wave of selling pressure, one that might have little trouble dropping down to test the Fibonacci 162% support level near 15.39. Those of you who read my last two silver-related articles (in late December 2009 and early January 2010, respectively) already know there are several major daily and weekly support levels between $15.30 and $15.70 in this market, so there is a good chance that silver may finally land on more solid footing should it decline to these levels.

One reason silver appears to be destined to eventually break below the 200-day EMA is the strongly rising average directional movement index (ADX) (yellow line at bottom of the chart). This indicator measures the intensity of a given trend, with readings above 25 generally thought to be indicative of a strong trend in motion. It's still a few points shy of 25 right now, but it is still rising smartly enough to warrant further attention.

Again, the price action near the 200-day EMA will be critical for daily (and intraday) silver traders to monitor, as powerful reversal and/or breakdown moves are likely to be seen here, and soon. Silver's weekly price cycle is still in a mode that seems to favor a move down below the 200-day EMA/Fibonacci 127% expansion level toward the mid- to upper $15 range.

Shorting silver right here is probably a little south of sane, given that it's already down for five of the past seven sessions and the close proximity to the aforementioned major support area. However, depending on the strength of this downthrust, selling out-of-the-money silver put options might be a cash-generating play of interest for those able to trade futures options with their particular broker. Here are a couple of ideas for you to kick around:

Sell one March 2010 COMEX silver $15 put option for 0.120 or better (that's $600 cash that goes into your margin account, before commissions). This option expires on February 23, 2010, so it's on the fast track to extinction due to ever-accelerating time decay, and given all of the potential support areas that separate the current price of silver ($16.58 as this is written) from that $15 strike price (at which point the option goes in-the-money), this appears to be a modest-risk option credit strategy.

Risk control on the trade is simple -- if the price of the option doubles, you bail out of the trade, no questions asked, buying your short put option back as soon as possible. If silver gets hung up around the 200-day EMA or even stages a minor bounce higher in the days after selling your put, you'll be in the cat-bird seat, able to enjoy the twin blessings of ever-increasing time decay and shrinking option deltas. And even if silver keeps declining after you sell the put, if the rate of descent is slow enough, you may be able to still hold the trade long enough to realize a relief rally commencing well before the $15 strike is reached.

Conservative traders should probably wait to see what happens in the next few sessions to see how silver reacts to the $16.15 support area before attempting to sell any silver puts; you won't get as much premium (because the option loses more and more time value every day) but you'll have more peace of mind due to a better understanding of the technical state of silver, all else being equal. Do some analysis work of your own and talk to your broker regarding some of the finer points of selling futures options before taking the plunge -- it should be time well spent.

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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