There are plenty of investors that don’t trust ETFs for as a substitute for owning the physical metal in hand.

While this is completely understandable, it doesn’t’ mean that you can’t hedge what you own by using options on the GLD and SLV ETFs.

If you own thousands of dollars in precious metals, you are completely unhedged against severe market fluctuations.

Silver in particular displayed a lot of volatility in 2011, it had multiple 30% swings to both the upside and the downside.

The roller coaster ride was enough to make most owners a little bit squeamish.

The solution: Options.

If we take SLV as an example. We can purchase an (otm) out of the money put with 100 days till expiration, for .15 cents.

The catch: the put Is 30% out of the money.

That means you have unhedged for a 30% drop in the next 100 days, however, if silver were to drop precipitously the put would increase in value. The put would increase in value even if the spot price of silver didn’t fall below the strike price.

The reason, increased volitilty would make the put worth more than you paid for it. And at .15 cents, its pretty cheap protection for the next 100 days.

Hedging Gold (gld) is a little different. Gold hasn’t been as volatile as silver but you can still purchase a put that is 25% Out of the money for .20 cents. The question is though; with gold’s drop from 2000 does anyone expect it to drop another 25% this year? Either way- purchasing one put for 20 dollars, can protect your expensive gold holdings from a catastrophic drop.

I don’t favor purchasing puts less than 100 days before they expire, and I don’t believe the premium you have to pay for at (ATM) at the money put is worth it.

You are long term bullish on the metal, so it makes little sense to spend a ton of money to marry puts to your position at all times.

But, when the market is uncertain- owning a put is akin to owning insurance.

You insure all of your most precious assets, your precious metals must be thought of the same way.

If silver were to fall, you can sell the put for a profit, and purchase even more silver with it at the cheaper price point.

If the option expires worthless, as most do, then it would be the same as the premium you pay in your insurance policy- even if you never use it.

For bullish investors, I don’t calls work the same way. Instead of paying the premium for a call, you could just buy the physical. Most options expire worthless, so instead of wasting money on a call- you could own the metal in hand.

Its important to remember:

These puts are 30% out of the money. That means if gold or silver drop 15% your puts aren’t going to be worth much. The 15 dollar puts might be worth 100 bucks. Expectations need to correctly set.