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Gold is Approaching Pivotal Levels: How Options Traders Can Profit

By: OptionsANIMAL
Posted: 1/8/2013 12:54:00 PM
Referenced Stocks: GLD

By Greg Jensen

For most traders and investors, earnings season brings a focus on U.S. equities, often to the exclusion of all else. This is understandable. Stock prices are, after all, supposed to be a reflection of corporate profitability and this is when we get a snapshot of that. For those familiar with options in particular, the potential volatility around earnings reports can be traded, giving ample opportunity for profit (or, I guess loss!). This is all well and good but, given the interconnectedness of modern markets, that potential volatility can often overflow to other instruments, where there may be a better opportunity.

In the last few months, as stock markets have risen (S&P 500 +7.9% from November lows) so Treasury prices have fallen. Lower Treasury prices mean higher yields. Higher yields have led to a U.S. Dollar rally. This, in turn, has put downward pressure on gold prices. Whether you understand or accept this somewhat convoluted reasoning, the fact is that gold has lost around 8% from the October highs, and is at an interesting level.

 

You can see from the above chart that the 14 day moving average is fast approaching the 200 day. Add to this the fact that the 1650-1660 level formed the “shoulders” of previous head and shoulders formations and it looks like the level will be pivotal from a technical perspective. Volatility in stock and bond markets can only add to the mix. For options traders, there is no need to take a side. Gold may break through 1650 and complete the retracement to challenge 1500, or it may bounce off the level and re-test 1800. Whatever happens, I believe it is likely to move.

This future potential for volatility could be traded using the SPDR Gold Trust (GLD) options. I understand that GLD is not the same as gold itself, but for most people it is the most easily followed and traded proxy for the metal.

At the time of writing, using last traded prices and ignoring commission costs, a basic option straddle could be placed by buying March expiration 160 calls on GLD for 3.65 and puts with the same strike and expiration for 3.15. This would cost a total of $6.80 per share, giving a break even on the top side of 166.80, and 153.20 should gold break lower. This isn’t a cheap straddle to place but, given the potential for some serious movement, it could well pay off.

All of the news over the next couple of weeks will be around earnings releases. Follow them and trade them by all means, just don’t ignore opportunities that exist elsewhere.