Profiting From Volatile Gold with Options

Almost everyday in the financial press there is one or more stories on gold. It’s one of the hottest topics right now. This yellowish, soft metal has been tied to the rise and fall of economies for 1000’s of years.

The gold bugs still say it’s the best store of true value available, while the gold cynics dismiss these claims in today’s electronic, paperless monetary transfer society. There is truth in both these views. Value exists, at the core level, because a buyer and seller agree thus transact creating value for both. When the society, as a whole, agrees about value, this becomes a standard measurement against which other items are valued.

Gold has earned this standard over the millenniums. However, it can be argued, that it is losing its dominant position as fiat currency guided by electronic transfer and government credit ratings have moved into the forefront. Regardless of your opinion on the intrinsic value of gold, the fact remains that it is a tradable commodity that is very volatile right now.

Gold hit a high of 1033.90 in March, 2008. It has since pulled back and is trading around 917 presently. Price is resting very close to the 50-day SMA and is still above the 200-day SMA which is 888.65 This article will focus on how to use options to profit from gold’s short term volatility regardless of your macro view on direction or actual value.

Daily Gold Chart

The primary gold ETF, ticker symbol ^GLD^ is the underlying instrument for the option strategies. It closely tracks the price of gold, is very liquid/transparent, and offers easily accessible options to traders. Let’s explore 3 option strategies that make sense depending on your bias. These strategies assume you are willing to risk $2000.00 and have a 6 month time horizon.

Daily GLD Chart

Bullish: Real gold bugs invest in physical gold, buying gold itself in hopes of price appreciation. Over the ultra long term, this has proven to be profitable. However, buying gold outright, can easily lead to losses in the normal investment horizon and can be disastrous in the short-term. If your bullish in the short-term, options on GLD make sense. You have liquidity and some strategies hedge your bullish view. You can simply buy calls or trade a spread to express your opinion. A Bullish Call Spread is one way to trade the bullish opinion. Here is a current example of how to execute this strategy:

Buy 2 December 81 Calls at $10.90, symbol GLDLC

Sell 2 December 99 Calls at $2.60, symbol GLDLU

Your maximum risk is $1660.00 and the maximum gain is $1940.

Bearish: You believe gold is over rated and a dinosaur in the information age of fiat currency. This recent run up is strictly hype driven and gold will quickly fall back dramatically giving up all the gains. If this is your opinion, you can simply buy Puts on GLD. However, if you are a little less cynical, a Bearish Put Spread makes sense. The following is a current example of this strategy:

Buy 1 December 99 Put at $11.70, symbol GLDXU

Sell 1 December 77 Put at $ .95, symbol GVDXY

Your maximum risk here is $1075 and the maximum profit is $1125.00

Neutral: If you’re a gold agnostic, believing price will simply stay in a tight range, a Call Ratio Spread makes sense. Here is an example:

Buy 13 December 95 calls at $3.90, symbol GLDLQ

Sell 26 December 99 calls at $ 2.70 symbol GLDLU

Your total investment here is $1950.00 and the max gain is $7150.00

These are just a tiny sampling of the multiple options strategies that can be used to express your opinion on gold. Regardless of your conviction, remember to only use risk capital and position size properly at all times.

Best Wishes!

David Goodboy is Vice President of Business Development for a New York City based multi-strategy fund.

With 82% winning ETF trades in the model portfolio from October 2008 through March 2010 – you too can realize this level of success with Larry Connors’ Daily Battle Plan.