Here is a relatively low-risk spread to exploit overbought conditions in gold from Carley Garner.
The gold bulls are having a ball, but along the way, bearish option sellers have been provided with attractive opportunities. Here is one of those opportunities.
Due to the excitement and fear surrounding the U.S.-China trade skirmish and currency market complications, gold call options are grossly overvalued. Option sellers are likely salivating at the idea of selling gold calls, but we’ve learned the hard way that the old adage regarding option writing—picking up nickels in front of a steamroller—is accurate, particularly in precious metals. Nevertheless, we have found a way to attempt to take advantage of that with very little risk.
It is possible to create a reasonable risk/reward position selling horizontal call spreads using the October 1575 calls and September 1575 calls. Specifically, selling the October 1575 call and buying the September 1575 call as a hedge. This spread should collect about $600 in premium (the maximum profit on this trade before transaction costs). The risk cannot be definitively quantified because we are dealing with options in differing expiration months. However, the intrinsic risk is zero as long as the September call is in place. The September call expires in 21 days, which means the market will need to make a move within that time frame for the strategy to work as planned. The short October call expires in 50 days, so if gold doesn't reverse or at least fail to move above 1575 in the next 21 days we will be forced to either buy fresh insurance or exit. In any case, the loss potential in the next three weeks should be minimal. If gold reverses, the spread stands to lose value relatively quickly. The October 1575 call was worth a mere $100 a few days ago.
The margin required for this position is roughly $776, assuming your brokerage is charging exchange minimum margin. If your broker charges more, it might be time to consider a new brokerage for this type of trading or at least to have a chat. The delta on the position, which represents the pace of profit and loss relative to the futures contract is about .11. This means that for every dollar in price change the gold futures market experiences, this option spread will move a dime. If you are familiar with commodity math, we are talking about $100 and $10 respectively to a trader. In short, this spread slows things down and offers a relatively low-stress venture into bearish gold positions. Of course, when option selling the profit potential is limited, so this type of approach won’t create massive wealth, but it shouldn’t put a dent in portfolios should the speculation be inaccurate.
Carley Garner is the Senior Strategist for DeCarley Trading, a division of Zaner, where she also works as a broker. She authors widely distributed e-newsletters; for your free subscription visit www.DeCarleyTrading.com. She has written four books, the latest is titled “Higher Probability Commodity Trading” (July 2016).
