So I had a few choices. I could just sell out of my stock. I could try selling covered calls on the way down with the hopes of buying them back. But what I chose to do instead was to buy puts.

A put contract goes up in value as a stock goes down in value. So as the price of silver goes down my put value increases, which more or less offsets any decline in the stock price. It’s not an exact one-for-one because the options that I chose was out of the money and had a delta of around .5. This means that for every one dollar drop in silver the put increased by $.50. As silver continues to drop, the delta of my puts goes up though. These are technical details that can be addressed in a separate post.

The end result is that I have maintained my position, and offset my potential losses. So when silver turns around, which it will at some point, my potential for profit will be immediate. I don’t have to wait for silver to go back up into the low $30s before I can make more money. I’ll make money immediately after the turn around.

So the question is when will silver go and turn around?

That is a much harder question to answer. We know that the most recent support for silver was around $25. I would expect there to be at least some hesitation when silver hits that point. Whether it will rebound from $25 or not depends on what’s going on. The financial markets are in a state of high anxiety right now. Nobody knows what is going to happen with the fiscal cliff and the U.S. Congress.

Now from a rational perspective, we know that the fiscal cliff doesn’t really matter. It’s a drop in the bucket compared to everything else that’s going on between the monetization of the debt, foreign-exchange rates, and the devaluation of fiat currencies around the world. But that doesn’t stop the market from reacting violently to this minor fluctuation.

These kinds of waves in the market create buying and selling opportunities. As silver declines, it will be a great entry point if you don’t have some already. We know that over the long term the stock of silver in the world has been depleted and the amount of dollars (and euros and yen and yuan) being created are increasing. So there is nowhere for the price of silver, and gold, to go but up. Along the way, there will be waves going up and down, but like I said, those are simply buying and selling opportunities.

That’s why I did not want to sell my SLV. I want to make sure that I keep my position for when the trend resumes upward. And then I can continue selling covered calls to create income from my silver and turn silver into cash flow.

Honest Silver and Gold, LP’s goal is to provide consistent cash flow on your investment while minimizing risk from the ups and downs of the market.

Honest Silver and Gold, LP is a Georgia limited partnership that invests funds in physical precious metals. The fund’s aim is to profit between the arbitrage of buying and selling while reducing risk through the use of puts on exchange traded funds (ETFs) whose value reflects the market prices of silver and gold.

To get a better understanding of how the limited partnership works follow this guide:

First, Read the 5 Steps to Turning Silver and Gold into Cash Flow to understand the basics of how buying and selling precious metals can turn into profits

Second, Read How This Fund Works to learn about the actual mechanics of how you become involved in the limited partnership.

Third, email me at neal@honestsilver.com to get more information on becoming a limited partner

I wanted to talk for a minute about the logo. On the left side of the logo are “junk” silver coins. On the right side of the logo are $100 bills. That’s really what Honest Silver is all about, turning silver and gold into cash flow.

The actual coins in the logo are mine. They are part of the profits from previous deals that I have personally done in the same way that the partnership will do so. Following the 5 Steps, I bought under-market silver, hedged it through puts, sold it at the market level, and unwound the hedge. Since silver is in a rising trend overall, I decided to keep my profits in silver form rather than cash out entirely.

Net result? My cost basis in the coins in the photo is… Zero. Nothing. I could sell them at any price, at any time, and make money. So don’t wonder if all this talk will actually work. It does and the coins in the logo are the proof.

Here’s how it works.

First, I am keeping the fund small. This means fewer than 35 unaccredited investors and less than $5 million in total assets. Keeping the fund small means there are no regulatory or reporting requirements. I have neither the desire nor the patience to deal with that kind of nonsense.

Second, I’m the guy. I make the buying and selling decisions for the fund. I also have an interest in the general partner, Honest Silver and Gold Buyers, LLC.

Third, the mechanics on your part are very simple. Get two copies of the documentation package. It’s about 150 pages saying exactly what I just said in the two paragraphs above. Read it, have your lawyer read it or whomever else you want. Then send me one signed copy of the agreement and a check or wire for at least $10k. When I receive both the agreement and the funds, you’re in. From here on out, you sit back and collect quarterly checks (I might do monthly if you want).

Fourth, I go out, following the 5 steps, buying silver (and gold) under market, hedging the position against market fluctuations, and selling at market. We make somewhere around 8% per month (not guaranteed, past returns are no indicator of future performance, etc etc legal disclaimer) and profits are split 50/50. There are no management fees or asset fees or any other kind of fee. I make money only if you make money.

Fifth, I will be updating this blog with transactions as we go along so everyone will be up to date as to what is going on.

So to talk to me about getting your copy of the placement documents, email me at neal@honestsilver.com

More to come soon….

1. Buying fake silver/gold. All purchases are tested to avoid this, but tests could be wrong.
2. The options exchange crashes. It is possible that the market in which we buy and sell the put hedges could crash. If we have a position open at that time, this would have a profound effect on the price or marketability of our hedge.
3. Shipping theft. All shipments will be insured to address this, but insurance could be stalled/denied.
4. Market volatility drops precipitously. The price of our put depends partly on the volatility of the silver or gold. If silver or gold suddenly flatlines, the put will be worth less no matter what the actual price is.

I will add to this list over time as more risks become known. If you have a question about a risk and would like to see it addressed here, post a comment below.

Incidentally, there is something that sounds like a risk but isn’t. If the paper funds (mainly SLV and GLD) are proved to not have the assets that are claimed, then this will actually be very good. The SLV/GLD price will plummet while the price of physical metal will increase. Both the hedge and the bullion would increase in value!

Only time will tell if Mr. Chu is correct or not. I tend to doubt it, personally. What I do not doubt though is that commodities, and especially silver, are very volatile. It is against this up or down that we protect our positions with puts. Let’s say one day the world wakes up and discovers that silver is in fact no good for anything, and the price plunges to $2. That’s OK, our puts will gain in value as the silver loses value.

That’s the purpose of hedging: to offset risk.

Welcome to the wonderful world of hedging. The term “hedge fund” gets thrown around a lot, but it’s really very simple. A hedge is a position you take to offset risk in another position. A hedge fund is a fund that, theoretically, uses hedges to minimize risk.

Here at Honest Silver and Gold our risk is very well defined. the difference between sales price and purchase price is our profit. Therefore, as the market price of silver or gold declines, so does our profit. In extreme circumstances, this could become negative and translate to a loss! This is something to be avoided.

The question now becomes, “How do we protect from drops in market price?” Fortunately, this has a simple answer: puts. A put is a contract that allows the purchaser of the contract to sell the underlying asset at an agreed-upon price until some expiration date. I realize that can be confusing, so let’s look at an example.

John wants to insure his 100 ounces of silver against loss of market value because silver has hit a high of $45. He buys a put on the open market that has a strike price of $47 and an expiration date 6 months from now. The cost of this put is $5.

John does this because he doesn’t want to lose his profits, so he’s willing to buy this insurance, aka “hedge.”

Let’s see what happens when silver moves in price. If silver drops to $35, his right to sell at $47 is now worth a lot more money. If someone offered you the chance to sell $12 above market value, wouldn’t you take it? Of course you would. So that put that John bought is now worth $12 (or more depending on how much time has passed). His silver dropped by $10, but his put went up by $7. The $3 loss is what John paid for the duration of the insurance. Overall, he reduced his loss to a maximum of $3.

On the other hand, if silver goes up to $55 instead, the picture changes. John’s put will be worth much less, but his silver will have gained $10. Let’s say John holds the put until it expires worthless, he has gained $10 in silver value and lost $5 on his put, for a net gain of $5. In this scenario the put reduced potential profits – that’s the price of insurance.

Now that you understand how a put functions, it’s important to understand how this applies to Honest Silver and Gold, LP. We use puts to protect our purchases until we can sell them. If we buy silver at $35 when the market value is $43 and spend $6 on a put, our worst case scenario is a $2 profit (43 – 35 – 6). Ideally, the silver will be sold as quickly as possible. After the silver is sold, the put can be sold back into the market (Step 4) for close to what we paid for it. This will mean we get the insurance for close to free, maximizing the profit at around $8.

Step 1: Buy silver and/or gold at under the current market value.

Step 2: Buy long-dated (4+ months to expiration) puts

Step 3: Sell the silver/gold at close to market value

Step 4: Sell the puts back into the market

Step 5: Profit

That’s all there is to it! Of course, the devil is in the details, so each one of these steps will be discussed individually as to how it is achieved.

The oval average increase was 4.6% over the past 10 days. In case that sounds small, let me emphasize that this is a HUGE increase over such a small period of time. Now it is true that this was just an isolated sample, and the rate of price increase will probably revert to its mean, but that’s not what matters for gold and silver.

What does matter for gold and silver prices is that when price shocks like this start occurring, people lose confidence in the government run money. They turn to gold and silver as commodity money that holds its value instead.

What happens when the largest precious metals consumers get spooked and want to hold on to their wealth? They buy gold and silver. Silver especially since it is so much cheaper than gold.

Chalk up another point for the bull case for commodities, especially gold and silver.

As to why Chinese inflation is going so fast, it has to do with the trade relationship the Chinese government establishes with the exporters in China. The Chinese government prints enough money to keep the yuan weak versus the dollar. That way Chinese goods remain cheap for Americans (and everyone else too) to buy. Great for the chinese exporter, lousy for the other Chinese people. This is now backfiring because the US (and everyone else too) are printing more and more money, so the Chinese government is following suit.

–from the iPad