A Golden Butterfly to Follow

10/18/2019 9:37 am EST

Focus: COMMODITIES

Jay Soloff

Editor, Options Profit Engine

A recent butterfly spread in GLD may provide clues to the direction of gold, reports Jay Soloff.

Although the stock market has had its share of ups and downs over the last couple of months, the price of gold has been surprisingly stable. Gold futures held a strong spring and summer rally, reaching $1,500 per ounce by August. Since then, gold has stabilized and futures are still right around that $1,500 level.

Why have gold prices remained elevated despite the volatility in the stock market? It could be due to the very same volatility. Investors may be looking for something a bit more defensive, and gold fits the bill.

While gold has often been seen as a hedge against inflation, it can also benefit in a deflationary environment. Generally speaking, lower interest rates can cause the attached currency to drop in relative value. In other words, if the Fed keeps lowering rates, it should decrease the value of the dollar versus other currencies.

Gold has no such interest rate attached to it. So, as other currencies lose value with global rates falling, the price of gold can move significantly higher.

So, falling interest rates have helped get the price of gold around $1,500. But what’s in store for the future? Can gold go even higher? Can we get back to the highs above $1,900 from 2011?

Predicting the price of any tradable asset is a major challenge, but at least one large trader or fund is betting on a big move higher in SPDR Gold Shares (GLD).

GLD is a heavily traded ETF that tracks the price of gold bullion. It is one of the most popular way to trade gold. Its options contracts are also heavily traded.

Recently, a trader put on a trade called a directional butterfly. This type of strategy makes money if the price of GLD moves into a certain range. In this case, the trader bought a call butterfly at the 146-150-154 strikes for 21¢ expiring in November. That means the max gain occurs if it expires at $150 at November expiration, but a price anywhere from $146.21 to $153.79 is profitable.

The reason the trade works the way it does is that the middle strike (150) is sold twice the amount of the outside strikes (146,154). This keeps the cost low and creates the range-bound profit structure of a long butterfly.

What’s interesting about this trade is that it was executed 17,000 by 34,000 by 17,000 times! That’s about as large of a butterfly as you’ll ever see traded at one time. There is clearly a lot of conviction around this strategy.

The most this trade can lose is the 21¢ per butterfly. At a max gain of $150, it can generate $3.79 in profit. However, hitting max gain is improbable because it occurs precisely at $150. On the other, having the price of GLD fall within the profitable range is a lot more likely since it’s about $7.60 wide.

GLD

The thing is, this is almost certainly a very bullish trade on gold. GLD would have to climb from below $140 to at least $146.21 to break even. Of course, $150 is the optimal target, which is more than $10 higher than the current price.

A large position like this could be a decent indicator that gold is going higher before mid-November. What's more, if you can trade spreads in your options account, you can easily copy this trade as it won’t cost you much at all in the way of capital requirements.

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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