Option Strategies for Trading the Yellow Metal

Gold bars Gold investors should “rush to the exits,” so said hedge fund manager and newsletter editor Dennis Gartman, in a note to clients earlier this week. He noted that the rally in the yellow metal has “gone parabolic” and should be sold.

Gold has been a big topic of discussion across the market of late, but what’s the best way to trade it? Gold bars? Futures on the commodity itself? An alternative strategy is to trade options on the SPDR Gold Trust GLD. Two hypothetical options trades on this ETF – one neutral, one bearish – are described below. Remember that these are merely examples, not recommendations. Consider your own risk/reward parameters and trading style before executing any new trades.

*Prices given as of Wednesday morning

Bearish Option Strategy: Bear Put Spread

Those who agree with Mr. Gartman and believe a bearish path lies ahead for the metal could buy an intermediate-term put spread. The July 118/115 put spread can be bought for $1.55 currently. If GLD, currently trading at $117.10, is above the 118 strike when the options expire, the trader relinquishes the entire debit paid.

Maximum profit, on the other hand, is capped at $1.45 on a move below the 115 strike. Investors who believe the fund could move lower, at least about 2% in the next two months could consider this spread as a relatively conservative way to yield a 94% return on risk. Breakeven for this strategy is $116.45, so if GLD is trading anywhere below this level at expiration, the spread will be profitable.

Neutral Option Strategy: Short Strangle

Investors who think gold is not going lower but may trade sideways for several months could consider a short strangle. A strangle is the simultaneous sale of an out of the money call and a put in the same month but with different strike prices. Volatilities have spiked of late, making premiums a little richer for those selling options. The September 114/121 strangle can be sold for $9.85 (by selling the 114 put and selling the 121 call).

If the ETF is trading between these strikes when the options expire on September 17, the strangle seller keeps this entire premium as profit. In fact, the strangle is profitable anywhere between $104.15 to the downside and $130.85 to the upside. Be aware potential losses are unlimited for a short strangle if the ETF rallies above breakeven and capped only at the zero level if the fund sharply declines.

Profit/Loss of GLD short strangle

Does Gold Have a Bright Future?

Do you think gold will lose some of its luster soon or does it still have safe-haven appeal? Or do you avoid commodity-driven trading altogether? We’d love to hear what you think.

Have questions about opening a brokerage account? Join Jared Levy and Bryce Bruner next Tuesday for a free “Brokerage Basics” webinar.

Photo Credit: covilha

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