Gold prices have logged a string of record highs during the past
couple of weeks, as the precious metal thrives in the midst of
economic uncertainty and volatility in the equities market. At last
check, the December gold futures contract was up $3.50 at $1,295.20
an ounce, with many speculators expecting the price to rise above
the $1,300 level in short order. However, some options traders are
not convinced of gold's staying power, as evidenced by today's
flood of put volume on the SPDR Gold Trust (
As I noted in my
, GLD has seen more than 54,000 puts cross the tape today, more
than doubling the trust's average daily put volume. But, while the
weekly September 124 contract has attracted the most attention --
more than 10,000 contracts -- there was a much more interesting
transaction that took place at the October 126 strike.
Specifically, a block of 3,300 put contracts traded at the ask
price of $1.77 on the Chicago Board Options Exchange (
) at about 9:56 a.m. Eastern time. This block was marked "spread."
The other half of this trade crossed on the October 126 call, where
a block of 3,300 contracts traded at the same time on the same
exchange for the bid price of $1.98. Given this data, it would
appear that we are looking at a
position on the SPDR Gold Trust.
The Anatomy of a SPDR Gold Trust Synthetic Short
Before we get into the particulars, a synthetic short options
trade attempts to replicate as closely as possible a short position
on a stock, or, as in this example, an exchange-traded fund (
). The trader buys at-the-money puts and sells at-the-money calls
in equal numbers at the same strike with the same expiration date.
By using options, the trader gains considerable leverage, allowing
for greater returns on the position than those that would be
achieved by investing the same amount of money in a short stock or
This particular synthetic short on GLD breaks down as follows:
The trader bought 3,300 GLD October 126 puts for the ask price of
$1.77. The total debit incurred for entering this position would be
$584,100 -- (1.77 * 100) * 3,300 = $584,100. At the same time, the
trader sold 3,300 October 126 calls for the bid price of $1.98. The
total credit for entering this leg of the position arrives at
$653,400 -- (1.98 * 100) * 3,300 = $653,400. Combining this leg of
the trade with the purchased October 126 put results in a
of $69,300 -- $653,400 - $584,100 = $69,300 -- minus brokerage fees
and margin requirements.
The maximum profit on this trade is equal to the purchased put
strike plus the credit received upon entering the position. Since
the initiation of the trade resulted in a credit of $0.21, the
maximum profit is $126.21, or $12,621 per contract -- $126 + 0.21 =
$126.21. Since there is no cap to how high GLD shares can rally,
the potential losses are theoretically unlimited. Breakeven,
meanwhile, is calculated by adding the net debit to the strike
price of the purchased October 126 put, and arrives at $126.21.
Below is a chart for a rough visual representation of the trade's
Rising implied volatility is pretty neutral for a synthetic
short trade. It lifts the value of both the purchased and the sold
options, thus increasing the cost to buy back the sold call and
boosting the premium received when selling the purchased put. At
the time of the trade, implied volatility for the GLD October 126
call rested at 14.60%, while implieds for the October 126 put were
15.05%. The ETF's one-month historical volatility rested at 23.29%
as of the close on Wednesday.
Synthetic Short Versus a Short Sale
On a final note, let's run a quick comparison to see the
difference between a synthetic short option position and a short
stock trade. For this example, assume that Trader Bob sold 100
shares of GLD short for $126 each, the credit being $12,600
(excluding margin requirements and broker fees). Meanwhile, Trader
Joe sold one October 126 call and bought one October 126 put,
resulting in a credit of $0.21, or $21 per pair of contracts
(again, excluding margin requirements and broker fees). Both
traders control 100 shares of GLD, but Trader Bob pocketed $12,600
while Trader Joe banked $21 per pair of contracts, (although Bob
still owes his broker 100 GLD shares).
Let's say that GLD closes at $124 per share on October
expiration. If Trader Bob closes out his entire position, he would
earn $2 per share, resulting in a profit of $200. For Trader Joe,
the October 126 call would expire worthless, while the October 126
put would be worth $2. As a result, Trader Joe would earn $2 plus
his initial credit of $0.21, bringing his profit on the entire
position to $2.21, or $221 per pair of contracts. Now, imagine if
Trader Joe had risked the same amount of capital as Trader Bob, and
you can see why synthetic short option trades can be quite
lucrative for bearish traders.
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