Silver Dividends: Covered Calls on Precious Metals

January 22, 2025

I love dividends but hate when companies cut or stop them. I also see precious metals, which are actively used in industry, as a strong inflation hedge, just like real estate—and I see covered calls as the way to combine both.

  • Dividends are a key attraction, but cuts or suspensions are a dealbreaker.

  • Precious metals, actively used in industry, offer strong inflation protection.

  • Covered calls can help combine the stability of dividends with the value of precious metals.

Combining Dividends and Precious Metals through Covered Calls

Investors, including myself, often find dividends to be one of the most attractive aspects of owning stocks. The promise of steady, reliable income is hard to beat, especially when you reinvest those dividends or rely on them as a passive income source. However, a sudden cut or halt in dividends can be frustrating and significantly damage the long-term returns of a stock. I’m not alone in feeling this way; many investors find themselves disillusioned when companies, often for reasons related to market volatility or economic uncertainty, decide to reduce or suspend their dividend payouts. This makes finding an investment strategy that balances dividend income with the protection of capital incredibly important.

On the other hand, I’ve also always had an affinity for precious metals like gold, silver, and platinum. These metals have long been viewed as a reliable hedge against inflation, often outperforming traditional equities during periods of economic uncertainty. More importantly, these metals are actively used in various industries—such as technology, automotive, and renewable energy—ensuring consistent demand that supports their value. This industrial demand, paired with their historical role as stores of value, makes them an attractive investment in times of market instability. In my view, precious metals can act as a hedge against inflation in the same way real estate can—by providing a stable, tangible asset that holds value even when fiat currencies are devalued.

But here’s the real question: How can I combine the benefits of dividends with the inflation-protecting qualities of precious metals? The answer, I’ve found, lies in the strategy of covered calls.

What is a Covered Call?

A covered call is a popular options strategy in which an investor holds a long position in an asset, like a stock or exchange-traded fund (ETF), and simultaneously sells a call option on the same asset. The key here is that the investor already owns the underlying asset, making it “covered” in the event that the call option is exercised. The goal of this strategy is to generate additional income from the option premium, while still holding the underlying asset.

In the context of combining dividends with precious metals, covered calls can offer several advantages. For example, if you own shares of a mining company or a precious metals ETF that regularly pays dividends, you can sell call options against those holdings to generate extra income. The best part is, even if the price of the underlying asset increases and the call option is exercised, you still retain the original value of your position—plus the premium income from the call and any dividends you received during the period.

Writing a covered call on silver through an exchange-traded fund (ETF) when you own 1,000 ounces of silver can be done by purchasing shares in a silver ETF that tracks the price of silver (e.g., SLV, which is the iShares Silver Trust) and then selling call options against those shares. Here's a step-by-step guide on how you could execute this strategy:

Step 1: Determine the Number of Shares Needed

Silver ETFs like SLV typically represent a specific amount of physical silver per share. For example, SLV holds approximately 10 ounces of silver per share. If you own 1,000 ounces of silver and want to write a covered call, you would first need to purchase 100 shares of SLV (since 1,000 ounces ÷ 10 ounces per share = 100 shares).

Step 2: Decide the Strike Price and Expiration Date

Next, you need to choose a strike price and expiration date for the call options you wish to sell. Here’s how you might think about these two factors:

  • Strike Price: The strike price is the price at which you are willing to sell your shares of the silver ETF if the option is exercised. If you’re bullish on silver and want to capture some upside potential, you could choose a strike price slightly above the current price of SLV (out-of-the-money). If you're willing to give up more potential upside for the premium income, you could pick a strike price closer to the current market price (at-the-money).

  • Expiration Date: The expiration date determines how long the option will remain active. For example, you could choose an expiration date 1-3 months out, which is a common timeframe for covered calls, or longer if you prefer to commit to the strategy for a longer period.

Step 3: Sell the Call Option

Once you've selected the appropriate strike price and expiration date, you can sell (or "write") the call option on the SLV ETF. This means you are agreeing to sell your SLV shares at the strike price if the option buyer decides to exercise the call before or on the expiration date.

For example, if SLV is trading at $23 per share, you could sell a call option with a strike price of $25 that expires in 30 days. Let’s say the premium for this call option is $1.50 per share. Since you own 100 shares of SLV, you would collect $150 (100 shares × $1.50 premium) as income for selling the call option.

Step 4: Potential Outcomes

There are a few potential outcomes when writing covered calls:

Outcome 1: SLV Stays Below the Strike Price

If SLV stays below the strike price ($25 in this example) by the expiration date, the call option will expire worthless. You keep your 100 shares of SLV and the $150 premium from the call option. Additionally, if the ETF pays a dividend during this time, you would continue to receive that income as well.

Outcome 2: SLV Rises Above the Strike Price

If SLV rises above the strike price (e.g., above $25), the call option buyer is likely to exercise the option and buy your shares at the strike price ($25 per share). You would be required to sell your 100 shares of SLV at $25 each, which is a profit of $2 per share (assuming you bought SLV at $23). In addition, you keep the $150 premium from selling the call. So, your total gain in this case would be:

  • Capital Gain: $2 per share × 100 shares = $200

  • Option Premium: $1.50 per share × 100 shares = $150

  • Total Gain: $200 (capital gain) + $150 (premium) = $350

In this scenario, you may have missed out on further upside if SLV continues to rise after you sell at $25, but you still profit from both the capital gain and the option premium.

Outcome 3: SLV Declines

If SLV declines in price, the call option will expire worthless, and you keep your 100 shares of SLV. You still pocket the $150 premium, and if you believe in silver's long-term upside, you can repeat the process by selling another call option in the future.

Step 5: Repeat the Process

Once the option expires, you can repeat the process by selling another call option, possibly with a new strike price and expiration date. The goal is to continuously generate additional income through option premiums, while still holding the silver-backed ETF for its price appreciation and any dividends that may be paid.

Example Breakdown: Writing a Covered Call on Silver ETF (SLV)

Let’s walk through a complete example with numbers.

  • Silver Position: 1,000 ounces of silver, which you want to represent via 100 shares of SLV (since each SLV share is approximately 10 ounces of silver).

  • Current SLV Price: $23.00 per share.

  • Call Option Strike Price: $25.00 per share (out-of-the-money).

  • Expiration Date: 30 days from now.

  • Option Premium: $1.50 per share.

  • Premium Collected for Writing the Call: $1.50 × 100 shares = $150.

Potential Scenarios:

  • SLV Stays Below $25: You keep the $150 premium, still own your 100 shares of SLV, and can sell another call in the future.

  • SLV Rises Above $25: The call option is exercised. You sell your 100 shares at $25 each, realizing a $2 gain per share ($200 total), plus the $150 premium from the option. Total gain: $350.

  • SLV Declines: You keep the $150 premium and retain your 100 shares of SLV, which might be lower in value, but you’ve offset some of that decline with the premium.

Advantages and Risks

Advantages of Covered Calls on Silver ETFs:

  • Income Generation: You collect premiums from selling call options, which can enhance your returns from silver ETFs.

  • Downside Buffer: The premiums you collect can partially offset declines in the price of the silver ETF, reducing your overall risk.

  • Flexibility: You can adjust the strike price and expiration dates based on your outlook for silver and your income needs.

Risks:

  • Capped Upside: If silver prices rise significantly, your gains are capped at the strike price of the call option. You miss out on any further upside beyond the strike price.

  • Exposure to Price Declines: While the option premium offers some buffer, if silver prices decline significantly, your losses could still be substantial, especially if the ETF’s price falls below the cost of your position.

Benefits of Using Covered Calls with Precious Metals

  1. Income Generation: Covered calls provide an additional stream of income through the premium you collect from selling the call options. This can supplement any dividends that the company or ETF is paying, creating a more robust income strategy.

  2. Downside Protection: The income you earn from the premium can offer some downside protection. In a down market, the premium helps offset any losses you might experience from the underlying asset’s price decline. While it’s not a full hedge, it provides a buffer against losses.

  3. Enhanced Returns: If the price of the underlying asset (e.g., a precious metals mining company) doesn’t rise above the strike price, you keep the premium, the dividends, and the asset itself. This could lead to enhanced returns on your overall position, as you effectively “layer” income from dividends and call premiums.

  4. Flexibility and Control: You have the flexibility to adjust the strike prices and expiration dates of your options to match your risk tolerance and investment goals. For instance, if you believe the price of gold will stay stable, you could sell shorter-term options to generate more frequent premiums, or if you expect some upside potential, you could select a higher strike price.

Risks and Considerations

As with any investment strategy, covered calls come with risks that investors should carefully consider:

  1. Capped Upside Potential: The biggest risk when writing covered calls is that your upside potential is limited. If the price of the underlying asset rises significantly above the strike price, you may miss out on potential profits. This is the trade-off for the premium income.

  2. No Downside Protection in a Severe Decline: While the premium can provide some downside protection, it won’t prevent significant losses if the price of the underlying asset drops substantially. Covered calls don’t provide the same kind of protection as more direct hedging strategies, such as buying put options.

  3. Dividend Impact: When you sell a call option, you still retain the right to the dividend payments, but if the stock is called away (i.e., the call option is exercised), you may lose the dividend payments in the future if you no longer hold the stock.

  4. Liquidity of Options: Options can sometimes be illiquid, particularly for less-traded stocks or ETFs. This means that you may not be able to sell options at favorable prices or may face a wider bid-ask spread, which could reduce the effectiveness of the strategy.

Combining dividends with precious metals through the use of covered calls offers a unique way to generate additional income while still benefiting from the long-term stability of precious metals. By carefully managing the strategy—selecting the right assets, strike prices, and expiration dates—you can tailor your portfolio to enhance returns while managing risks. It’s a way to balance the benefits of regular income (from dividends) with the inflation protection and long-term value of precious metals, all while maintaining some flexibility in how you approach the markets. If you’re an investor looking to hedge against inflation while generating income, this strategy could be a smart way to do so.