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Monday
Apr262010

Gold Options: Enhanced Leverage, Managed Risk

On the 8th of December 2009, we wrote an article exposing what we thought was an excellent opportunity for option traders. Gold was correcting from its end of year rally to $1225 and many believed that the yellow metal was heading back to three figures. However we disagreed and suggested a risky but potentially more highly profitable trade for those who also believed that gold prices were not going to drop below $1000. In this article we wrote, “We think that any put contracts expiring in the next few months, with strike prices below $1000/ounce of gold (or equivalent for GLD) are worthless. Therefore we think their prices will soon fall to reflect this, and so we are of the opinion that selling these puts is a good trade, with the plan being to purchase them back for mere cents as they approach expiration.”

“With gold enjoying strong support at about $1020-$1033 and GLD getting a great deal of support at around $100, selling out of the money Jan-10/Feb-10/Mar-10 puts on GLD with strike prices of roughly $95 appears to be a good idea to us, we would view the sale of those contracts as money in the bank”.

We suggested that investors who also believed gold was not going to fall below $1000, to short sell the $95.00 GLD Puts series (or equivalent gold option contracts), selling Jan-10 contracts trading at $0.32, Feb-10 at $0.76 and March-10 at $1.26.

Out of those contracts we suggested to short sell, ALL expired out of the money, meaning that they all ended up being worthless. So investors who short sold these puts could’ve have bought them back for as little as 1 cent on the day of expiration. Shorting contracts at $0.32, $0.76 and $1.26 and then buying back at $0.01, or even $0.05 is a very profitable trade, offering a significantly reward that we believed significantly outweighed the high risk of the trade.

 

This trade contains a higher level of risks than most trades we recommend in OPTIONTRADER. An example of a typical trade can be found here

 

Looking at gold going forward we are very bullish, since gold is making higher highs and higher lows and has a fairly clear path to $1200 again.

 

The situation that threatened to cast a shadow over the gold rally appears to be calming. We refer of course to the PIIGS, in particular the troubles in Greece, which were causing the EURO to slide and subsequently a rally in the USD, placing downward pressure on gold since it is priced in US dollars. We saw a relatively strong auction for Greek bonds last week and with more talk of bailout backing from the EU and IMF, it appears the situation is easing.. for now.

 

Given these factors and the conclusion that gold prices are heading higher, the question is how to best play the next move up in gold. Some like holding the physical metal, some the mining or exploration stocks, however we prefer options. Their versatility and adaptability means that any investor can take advantage of them and can tailor the risk in a trade to suit ones aversion to such risk, and by effectively managing the risk against the potential reward in the trade, we aim to optimize the risk/reward ratio for our subscribers and clients.

 

If you are tired of underperforming gold stocks and are interested in finding a different way to play gold, or are just interested in options trading and the service we offer, please visit our OPTIONTRADER page for more information. Subscriptions to OPTIONTRADER are only $99 for six months for $179 for a year, this includes being able to email us anytime with questions or comments.

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Sam Kirtley

26th April 2010

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