If you are a “chart” guy or gal you may have taken notice of some interesting developments in gold stocks over recent months. A strong argument can be made that a “bottom formation” has – well – formed and that price is now in the early stages of a new bullish trend. Is this an accurate picture? Let’s take a closer look.
The Chart Picture
The great thing about looking at price charts is that you can see pretty much whatever you want to see in them – er, I mean, there are many different possible interpretations. In Figure 1 we see a weekly bar chart for ticker GDX – the Market Vectors ETF that tracks a gold stock index. Figure 1 – GDX Weekly Bar Chart with Support, Resistance and Triangle pattern highlighted (Courtesy: ProfitSource by HUBB)
As you can see there is a (OK, somewhat subjectively drawn) support and resistance range between roughly $20 and $32. There is also a triangle pattern forming as price consolidates into a more narrow range. Now for the record I got burned by incorrectly guessing the direction of a triangle breakout in ticker GLD recently (link), but I am not much of a “Once bitten, twice shy” kinda guy. For me it’s more like, “Fool me once, shame on you, fool me twice – damn! I fell for it again.” Cest la vie.
Still, the point is that price action seems to be “coiling” within a larger trading range, so now is the time to start planning what action to take, if any.
In Figure 2 we see a weekly bar chart for ticker GDX with the Weekly Elliott Wave count plotted, as calculated objectively by ProfitSource from HUBB. Figure 2 – GDX weekly with Elliott Wave (Courtesy: ProfitSource by HUBB)
As I always I should point out that I do not “blindly trust” Elliott Wave counts. Sometimes they play out with “uncanny accuracy”, other times, well, not so much. Still, for what it is worth, the current count is projecting a potential move from $26 to roughly $38 to $42, potentially by the end of this year.
So this raises two questions:
Question 1: Do you think there is a chance that gold stock prices will advance in a meaningful way between now and the end of the year?
Question 2: Are you willing to risk a couple hundred bucks while waiting to find out?
Option Plays in GDX
As is always the case when dealing with options, the possibilities are limitless. One possibility is to use the “stock replacement strategy”. With this approach a trader buys a deep-in-the-money call option that will emulate a stock position at a fraction of the cost. For example:
*To buy 100 shares of GDX would cost $2,645
*To buy one December 20 GDX call would cost just $675
The Dec 20 call has a “delta” of 93 which means it will act like a position holding 93 shares of GDX, but will cost only 27% as much as buying the shares. The particulars for the Dc 20 call trade appear in Figure 3. Figure 3 – Long 1 Dec 20 GDX call @ 6.75 (Source: www.OptionsAnalysis.com)
An alternative would be:
*Buy 6 Dec GDX 28 calls @ 1.43
*Sell 6 Dec GDX 33 calls @ 0.32
This trade would cost $666 and the particulars appear in Figure 4. Figure 4 – Long 6 Dec GDX 28-33 bull call spreads (Source: www.OptionsAnalysis.com)
This trade has a delta of 170, which means it will act like a position holding 170 shares of GDX, i.e., up to a point it can make money much more quickly than the Dec 20 call position for the same investment $.
Comparing the Two Trades
Figure 5 displays the two trades (one Dec 20 GDX call for $675 versus six Dec 28-33 GDX bull call spreads).Figure 5 – GDX Dec 20 call versus GDX Dec 28-33 Bull call spread (Source: www.OptionsAnalysis.com)
The Dec 20 call enjoys unlimited profit potential and eventually could make more than the Dec 28-33 bull call spread. However, based on the earlier Elliott Wave analysis, we are looking at (OK, hoping for) a move to the $38-$42 range (which would be a huge move).
So if GDX does in fact rise between now and December the Dec 28-33 bull call spread enjoys better profit potential.
As always, there are many ways to play just about anything in the financial markets, particularly when options are involved. Also as always, I am not “recommending” either of these trades. The purpose here is simply to highlight:
*One way to trade options instead of stock shares and get essentially the same position at a fraction of the cost (i.e., the Dec 20 call).
*One way to create greater upside potential for the same cost (i.e., the Dec 28-33 bull call spread)
Finally – and also as always – there are tradeoffs and caveats to keep in mind. In this case, two that come to mind are:
1) GDX MUST move higher for either of these trades to make any money.
2) YOU MUST be patient and wait for the move to play out (assuming it does) over a multiple month period of time.
Which leads us to close with:
Jay’s Trading Maxim #57: When patience is required in trading – the urge to become impatient suddenly tends to surge. So prepare yourself mentally to fight the “urge to surge.”