Gold stocks are known for being “volatile” – especially after they go for a while without being volatile. Figure 1 displays the recent price action for ticker GDX – an ETF that tracks an index of gold mining stocks.Figure 1 – Ticker GDX “coiling” in an ever narrower range (Courtesy AIQ TradingExpert)
(See also Trading Bonds Using Metals)
This action suggests that GDX may be setting up for a big price move. The problem is that if we pick an expected direction – be it up or down – and we are wrong, a loss is inevitable. Likewise, prices can continue to “coil” so it is difficult to predict “when” a meaningful move might take place.
Interestingly though, the implied volatility for options on ticker GDX has declined steadily to a multi-year low (See Figure 2). This kernel of knowledge tells us that GDX options are “cheap”. In a nutshell, the lower the IV for a given security, the less the amount of time premium built into the option prices for that security – meaning option prices are lower than they would be if IV was high. Figure 2 – Implied volatility on GDX options has declined to a multi-year low (Courtesy www.OptionsAnalysis.com)
(See also The World is Your Oyster – 11 Days a Month)
As you can see in Figure 3, the last time IV on GDX options bottomed at this low of a level, the price of GDX moved almost 30% in less than two months. Figure 3 – GDX price action with 90-day option IV (Courtesy www.OptionsAnalysis.com)
While there is no guarantee that such a move will occur this time around, the current setup – “coiling prices” and “cheap options” provides an excellent setup for an option trade known as a straddle. A straddle involves buying both a call option and a put option with the same strike price. No attempt is made to “pick direction”, instead we simply hope for a large move in one direction or the other.
As always this blog does not make “recommendations” and the trade that follows is highlighted simply as an example of one way to potentially take advantage of the current setup in GDX.
The example trade involves:
*Buying GDX September 22.5 call
*Buying GDX September 22.5 put
By using September options we give GDX 3 1/2 months to make some sort of meaningful price move.
The particulars and risk curves for this hypothetical trade appear in Figure 4.
Figure 4 – GDX September 22.5 long straddle (Courtesy www.OptionsAnalysis.com)
Things to note:
*Maximum risk is -$307 per 1-lot (this would only occur if GDX closes exactly at $22.5 a share on 9/15)
*106 days left until expiration
*Unlimited profit potential in either direction
*Breakeven prices at September expiration (9/15) are $25.57 and $19.43
Once again, this is not a “recommended” trade. It is simply one example of one way to play the current combination of “quiet and coiling” gold stock price and “cheap” options on GDX (i.e., low implied volatility).
Disclaimer: The data presented herein were obtained from various third-party sources. While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information. The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.