A Play in Gold

  • SumoMe

In the interest of full disclosure, this one is for speculators only. And if you’re a cheapskate (“Hi, my name is Jay”) that probably works in your favor here also.

But in a nutshell we are talking about “speculating in gold.” Now the very phrase – “speculating in gold” – makes some people snap to attention and greatly piques their interest.  It makes other people run like hell.  But in reality it all depends in large part on how you define “speculating in gold”.

If you define it as “scraping together every last dollar you can to put up as margin to buy as many gold futures contracts as you possibly can”, well, that’s one thing.  If you define it as “trading call options on ticker GLD” – the ETF that tracks the price of gold, well that is something slightly different.  As inferred in:

Jay’s Trading Maxim #56: Before you put on a trade, imagine the absolute worst case scenario.  If you can live with it, go for it.  If you can’t, just go away.

So buying a lot of gold futures contracts invariably involves the assumption of a pretty fair amount of risk.  Buying a call option on GLD, maybe not so much.

So Why Gold Now?

Gold – in my humble opinion and in highly technical terms – is about to do “something.”  And I would dearly love to tell you just exactly what that “something” might be.  Alas, my crystal ball is still out of order so I must rely on whatever the best clues available that I can find.

Factor #1: Gold is “Coiling”

In Figure 1 you can see that GLD is reaching the end of a triangle formed by an extremely narrow and ever tighter trading range.  Eventually price will break out.  According to us “technical analyst types” when price breaks out of a tight triangle it tends to move strongly in one direction or another.  I am willing to risk a couple of bucks that that will be the case here.  You of course, may feel differently.jotm20140521-01Figure 1 – GLD is “coiling” and Elliott Wave is still pointing to a higher projection (Source: ProfitSource by HUBB)

One possibility is to buy an option straddle or strangle – i.e., buy a call and a put option and hope GLD moves far enough to make enough money in one of the options to offset the loss in the other.  In this case I am looking to bet on the upside.

Factor #2: Elliott Wave is still point higher         

As you can also see in Figure 1, the Elliott Wave count – as calculated by ProfitSource by HUBB is still clinging to a higher projection.  I say “clinging” because clearly the expected time window for the move is just about up.  For the record, I am not expecting GLD to rise 12 points in the next several days.  But I am willing to play the upside.

Finding a Play in GLD Options

When it comes to selecting an options trade there are always a lot of possibilities.  One straightforward choice would be to buy a near the money call option with the highest “Gamma” value (which without a long explanation essentially affords you the most “bang for the buck” in my opinion).  So a trader could consider the July 125 call trading at $2.42.  This would cost $242 for a 1-lot and could generate a profit of close to $500 if GLD popped up to $132 a share.

Another choice would be to buy an out-of-the-money butterfly spread.  For example, one could:

Buy 3 August 130 call

Sell 6 August 140 calls

Buy 3 August 150 call

And even though this trade involves August options, let’s assume that we will plan on exiting this trade by 7/18 to avoid the negative effect of time decay in the month prior to option expiration. See Figures 3 and 4 for details.jotm20140521-02Figure 2 – GLD August OTM Butterfly Details jotm2014-0521-03Figure 3 – GLD August OTM Butterfly Risk Curves

As you can see in Figure 3, the total cost and total risk for this trade is $273.  Not exactly “betting the ranch.”  In fact this trade could be exited if GLD dropped below $122.  If that happened quickly, the loss would be something less than $273.

In Figure 4 we see that if GLD rises roughly one standard deviation in price to $132 a share, this trade can generate a profit near $500.


As always, this is not a “recommendation”, only an idea.  And in the end, let’s be honest, it might not even be a very good one.   Sure, if gold pops to the upside this trade may end up looking pretty good.  But if gold breaks to the downside – especially if it does so soon – this trade is going to look darn right foolish.  Which reminds me of:

Jay’s Trading Maxim #29: At the end of the day the question to ask is not “Was I right?”, but rather “How much did I make or how little did I lose?”

For now let’s ask the most obvious questions: Will GLD in fact break out to the upside?  And will this OTM butterfly spread generate a profit?  Now these seem like pretty reasonable questions, but the reality is that no matter what you or I think, they can only be answered with certainty in hindsight.

So let’s ask a more relevant question.  Do you have $273 bucks that you can afford to risk?

If your answer is “No” then by all means you should not consider this trade.  If your answer is “Yes”, that still does not mean that you should consider this trade.  If you have never traded an option or a butterfly spread before, I personally would prefer that you don’t make your debut here.  But maybe look for opportunities on your own to do something similar in stocks or markets that you are comfortable trading.

Limited dollar risk and an almost 2-to-1 upside to risk potential is something to think about. Maybe not now on my terms.  But maybe sometime in the future, on your own terms.

Jay Kaeppel