I recently wrote a piece discussing a super inexpensive way to play for a huge move in silver (in either direction) over the next year or so (I also highlighted the fact that it was super inexpensive because it was something of a long shot). This piece is very similar except that the play is much shorter-term in nature.
Gold Miners
As I intimated in the silver article, I grow a little weary of all the “hype” surrounding gold, gold stocks, precious metals, and so on and so forth. The bottom line is that:
a) There is a time to be in metals and/or miners
b) There is a time to NOT be in metals and/or miners
c) Like anything else, its often hard tell which time is which
d) But there is ALWAYS a loud contingent shouting “Now is the time to be in metals and/or miners!”
So, a few key points before we get to, eh, the point:
*I am not claiming A or B above – consider me agnostic. But please DO NOT consider me part of D above.
So, what’s the point? The point is that there is absolutely nothing wrong with making small plays in speculative situations.
Remember this:
*If you never get into a situation where you can make a lot of money (relatively) fast, then you will never make a lot of money relatively fast.
*HOWEVER, at the same time you MUST avoid the temptation to make this your primary form of investment. Bottom line: invest wisely with the bulk of your capital, but don’t be afraid to “take a shot” with a small amount of your capital if you think an opportunity exists.
If You Think an Opportunity Exists in Gold Miners….
So again, I am not telling you that I think gold miners are going to rally and that I think you should take action. What I am saying is that if you think gold miners are going to rally there are ways to profit handsomely. To wit:
Figure 1 displays the annual seasonal trend for ticker GDX as calculated by www.Sentimentrader.com. Note that Nov-Feb tends to be a bullish period.
Figure 1 – GDX entering a potentially favorable seasonal period (Courtesy Sentimentrader.com)
Figure 2 displays the Elliott Wave count for ticker GDX as calculated by ProfitSource by HUBB software.
Figure 2 – GDX with potentially bullish Elliott Wave count forming (Courtesy ProfitSource by HUBB)
Does the fact that GDX is in a favorable seasonal period AND has a potentially bullish Elliott Wave count forming guarantee that GDX is headed higher between now and sometime early next year? Not at all.
In fact if GDX drops much below $26 a share chances are the Elliott Wave count will fall apart.
But here is the point: If you are going to bet on miner stocks, this information “suggests” that that may be the way to bet.
The Play
There are a lot of ways to play. The most straightforward is simply to buy shares of GLD. 100 shares as I wrote would cost $2,623. However, I am going to highlight an alternative. It involves:
*Buying 2 GDX2020 26 calls @ $1.62
As you can see in Figure 3, this position costs $324 to enter (which is also the maximum risk on the position.
It also has a “delta” of 110 – this means that it will behave like a position of holding 110 shares of GDX, i.e., the profit or loss in dollars will be similar to holding 100 shares of GDX, but at a cost of only $324.
Figure 3 – GDX Jan26 calls (Courtesy www.OptionsAnalysis.com)
Figure 4 – GDX 26 calls risk curves (Courtesy www.OptionsAnalysis.com)
As you can see in Figure 4, the equation is pretty simple:
*If GDX does in fact rise in price then this position can make a large percentage return
*If GDX does NOT rise in price the trader could easily lose the full $324 spent to enter the trade.
From a “positions management” point of view the key questions for a trader are:
*Will you cut bait if recent support is broken – or will you just size the position so as to risk the full $324?
*If price does go up will you “let it ride” until GDX hits the 1st target of $32.58? Or will you consider adjusting or selling half if GDX pops up in the short run?
Also remember that “speculation” is a different game mentally than “investing.” Investing takes a longer-term mindset, speculation deals with the “here and now”. To wit, this trade could completely fall apart between the time I click “Publish” and the time you read this post. All GDX has to do is keep heading south as it has been doing pretty much non stop since the 1st week of September.
The lesson here is this: A speculator needs to be able to absorb a loss – mentally and financially – and not let it affect his or her thinking on the next opportunity (HINT: This is much easier said than done).
Summary
Is buying a call option on a gold miner stock index a good idea or a bad idea? That’s not for me to say.
But it’s one idea.
Jay Kaeppel
Disclaimer: The information, opinions and ideas expressed herein are for informational and educational purposes only and are based on research conducted and presented solely by the author. The information presented does not represent the views of the author only and does not constitute a complete description of any investment service. In addition, nothing presented herein should be construed as investment advice, as an advertisement or offering of investment advisory services, or as an offer to sell or a solicitation to buy any security. The data presented herein were obtained from various third-party sources. While the data is believed 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. International investments are subject to additional risks such as currency fluctuations, political instability and the potential for illiquid markets. Past performance is no guarantee of future results. There is risk of loss in all trading. Back tested performance does not represent actual performance and should not be interpreted as an indication of such performance. Also, back tested performance results have certain inherent limitations and differs from actual performance because it is achieved with the benefit of hindsight.
I really enjoyed this article. The idea identifying a possible inflection point (in this case by Elliot) and then using options to define ultimate risk of loss.
The 2 things that are not apparent to me is first, how many DTE on the purchased options, and second, is that an appropriate stop-loss other than your total capital committed to the trade. I’m not being critical though, the article was just bite-sized enough for me to learn the lesson intended. Thank you.
Don, not sure what you mean by “DTE”, but I am going to assume “days to expiration”. See Figure 3, in bottom line of info look for “Days”. in this case the days left to expiration is 105. Also as I pointed out in the article, each trade needs to decide on each trade how much $ they are willing to commit and how much of that amount are they willing to risk. In other words, a trader might decide to buy $2,000 worth of a given option but plan to sell if they lose a certain percentage of that (the risk in this approach is a large adverse price gap). the other primary alternative is to adopt a “% of total capital I will risk on each trade”, and divide that number by the price of the option and buy that many options. Ex., trader has $25,000 account and will risk 5% per trade. $25K x 5% – $1,250. If the option costs $200, then $1,250 / $200 = trader buys 6 contracts, maximum risk = $1,200 which is within their $1,250 maximum limit. Hope that helps, Jay
*Will you cut bait if recent support is broken – or will you just size the position so as to risk the full $324?