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Wednesday, March 23, 2011

Silver Arbitrage Trade Idea

I have been meaning to post more ideas and in depth commentary. Without further ado, here is one of my more recent musings.

Silver Arbitrage.

Short: PSLV
Long: SIVR

PSLV is Sprott Physical Silver. It is an ETF that is backed by physical silver. SIVR is ETF Securities ETF that is also backed by physical silver.

PSVL has a NAV of $14.18 versus its current trading price of around $17.39. This means that it is trading at an approximate 23% premium to NAV. SIVR on the other hand has a NAV of $35.77 versus its current trading price of around $35.96 (premium to NAV of 0.5%).

These two securities are tracking the same thing. PSVL has an expense fee of 45bps versus SIVR has an expense fee of 30bps. So annually all things being equal SIVR should outperform PSVL by 15bps (in the sense of lower tracking error). Both ETFs offer physical delivery options. PSVL has an advantaged tax structure in that it is taxed at the capital gains rate as opposed to SIVR which is taxed at the collectibles rate.

The arb here is pretty simple. I can argue due to the tax structure there should be some slight premium on PSVL vs. SIVR. That premium should be closer to the tax differential (assuming long-term rates 15% tax rate for PSVL and 28% for SIVR. So we can make an argument for a slightly less than 13% premium to NAV on PSVL (less due to management fee tracking error). This leaves us with approximately 10% of excess NAV that can be shorted away in risk free return.

PSVL has actually had its NAV widen recently as can be seen from the chart below:

A 10% risk free spread is fairly attractive. The key to executing the trade is making sure you are 1:1 on NAV. So you can't do it via 1:1 on shares of the ETF. The ratio actually needs to be around 2.5:1 shares short of PSVL to shares bought of SIVR. Once executed you will be completely hedged to the underlying movement of silver and will be able to capture the excess premium to NAV. It makes no sense why PSVL would trade at this much of a premium to NAV. Investors are begging to lose money at these prices.

This situation reminds me a lot of a similar trade put on with GLD (StateStreet gold) and PHYS (sprott gold)

At the time PHYS was trading at a steep premium and GLD was pretty much spot on NAV (like SIVR). Since that time GLD has traded up around 17% whereas PHYS is just up 5% so this is a 12% spread. This can be seen from the chart below:

I think PSLV and SIVR has a similar potential. This could potentially be realized very soon for a real high IRR. Even if it takes a year a risk free 10% is still very attractive.

If anyone has any questions or feedback let me know.


YCL said...

Is it easy to short PSLV or phys?

YCL said...


Wall-Street Wanderlust said...

The borrow can be a bit tight at times. It is worth noting that since posting the spread to NAV has collapsed from 23% to approx. 15%. Last time I checked the borrow was high but now hat silver has calmed down a bit it may be cheaper to borrow.

Hopefully this helps.