Gold Whale Bullish, But Sees End in Sight

08/30/2019 10:40 am EST

Focus: COMMODITIES

Jay Soloff

Editor, Options Profit Engine

An interesting large options trade suggests gold’s run is nearing a peak, reports Jay Soloff.

The price of gold is soaring for the first time in more than five years as investors have begun stockpiling safe-haven investment vehicles. Bonds, gold, silver, Japanese yen and other safe haven assets are seeing a significant uptick in demand as the global economic picture becomes murkier by the day.

Gold futures are trading over $1,550 an ounce. The most popular of the precious metal hasn’t been this expensive since the gold bull market after the credit crisis of 2008-2009. From 2011 to 2013 the price gold fluctuated between $1,600 and $1,800. We haven’t been close to that range since then, until now.

What’s interesting is that the economy is nowhere near the brink (of a disaster) like what we experienced in 2008. Sure, a recession is probably imminent. However, there’s a difference between a recession and the Great Recession of 2008. I certainly don’t see a banking collapse on the horizon—or the massive inflation expectations created by aggressive Fed intervention following the Credit Crisis.

That’s not to say we should ignore the signs. I don’t recommend piling into aggressive growth stocks right now. Between the trade war, the yield curve, and the deteriorating economic conditions, it makes sense to be wary.

Gold, in particular, seems to be attracting a lot of attention in the era of negative interest rates. The price is up more than 21% year-to-date and 9% for the last month. In comparison, the S&P 500 is up about 14% year-to-date but down 5% this past month.

So, what’s in store for gold? Is it about to top out or is there a chance it can get back to the highs of the gold-rush days of 2011-2013?

Let’s take a look at an interesting block trade in SPDR Gold Trust (GLD) options to see if we can find some clues. GLD is the most liquid gold ETF and possibly the most popular way to invest in gold.

An institutional trader purchased an Oct. 18 call ratio spread in GLD, which establishes a very strong bullish position. More specifically, with GLD at $145.50, the trader bought 5,000 146 calls and simultaneously sold 10,000 160 calls, both in October. The total cost of the trade was $2.25.

Done 5,000 times, it means the trader spent $1.1 million in premium on the trade. It breaks even at $148.25, with max gain at $160 on October expiration. That would result in $5.9 million in profits in that scenario.

If GLD closes below $146, the trade loses all the premium paid. However, since this is a ratio spread, there is unlimited risk potential on the upside (above $160) because half the calls would be naked above that level. (The other half is covered by the 5,000 long 146 calls.)

GLD

These large ratio trades are only done by institutions and funds due to the unlimited risk involved. Whoever made this trade believes gold has as much as 10% upside potential, but not any more than that. In other words, they are willing to risk a quite a bit that gold is going up, but within a 10% window. The reason they use the ratio spread is to substantially lower the premium cost of the trade.

Clearly, you shouldn’t make this sort of trade from home. Ratio spreads are best left to professionals. However, if you are bullish on gold, you can do a similar trade using a standard 146-160 call spread in GLD and have a defined limit to your risk. Or you could use a narrower spread to lower the premium costs as an alternative.

ED: The larger question is, what does the trader see. Apparently, he sees more market uncertainty driving gold higher but with an end in sight. Gold has rallied quite a bit already, especially given that we are not yet in a recession and there are no strong signs of an uptick in inflation. Perhaps it is a sign that you should tighten up your stops in gold if you are long.

Jay Soloff is the Options Portfolio Manager at Investors Alley. He is the editor for Options Profit Engine, an investment advisory bringing you professional options trading strategies, with all the bells and whistles of Wall Street, but simplified so all you have to do is enter the trades with your broker. 

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