The SPDR Gold Trust (ETF) (GLD) Is a Gold Mine for Free Profits

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Wall Street often uses gold as a safety trade. Case in point: Last week we saw the SPDR Gold Trust (ETF) (NYSEARCA: GLD ) as equity markets fell on headlines over renewed threats from North Korea. Also adding to the gold rally has been the precipitous drop in the U.S. dollar.

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Source: Jeremy Vohwinkle via Flickr (Modified)

Today, however, I want to short the gold rally … but with room for error. The headlines of war threats are inflammatory, but they should fade as the headlines become stale in kind.

Fundamentally, there is no denying the value of gold. It is hard to mine, and reports are that it's getting even more difficult. So if its rarity is increasing, then by default its value should be rising. Thus, my bet clearly is against the price action in GLD - not its fundamentals.

Click to Enlarge Technically, before the missile headlines, gold already had upside potential from a measured move perspective. My initial reason to attempt the short was my thesis that above current levels, the gold ETF should encounter resistance from previous attempts at breaking it.

I don't foresee the resistance to be one specific line, but rather a zone.

In other words, I don't want to just short GLD outright, as it would open me up to unlimited risk as long as the rally continues, without any room for error.

Instead, I will use options, where I can more cautiously implement my short. My idea is to open the position while premiums are inflated from headline risk, then buy back risk when fears abate.

Ideally, I want to let the premium expire worthless in my favor. But this is a dynamic situation, so I must remain flexible and open to the idea that I could be wrong. Luckily, I am not required to stay in my position through expiration. I can close them for partial gains or losses at any time.

How to Trade GLD

The Bearish Bet: Sell the Oct $134 naked calls and collect 60 cents to open. This is an aggressive bearish trade where I have an 85% theoretical chance of success. But - and this is extremely important - if the price of the ETF rises above my strike price, then I would become short GLD shares and would suffer losses for as long as it continues rallying.

To mitigate this unlimited risk, I can sell a spread instead. There, the maximum risk would be limited by the width of the spread. I could open the trade, then modify it as the threat changes.

The Safer Bearish Bet: Sell GLD Oct $133/$134 bear call spread (also known as a credit call spread). Here, I have roughly the same odds of winning, but with finite risk. If the spread wins, it would yield 15%.

I'm not a permabear on gold. In fact, I come into this trade with profits in hand from not one but two winning bullish trades on the GLD.

For a hedge, I could sell the Dec GLD $117 put for an additional 50 cents per contract. This would hedge my short thesis and provide overall balance. I ideally want to wait for a down day in the ETF to place this bet so I'm not selling puts at a discount when the gold fund rallies.

Investing in the stock market never comes with guarantees. That's why you should never bet more than you can afford to lose.

Learn how to generate income from options here . Nicolas Chahine is the managing director of . As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him on Twitter at @racernic and stocktwits at @racernic .

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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