Sunday, November 29, 2009

Gaming the Gold Bugs Redux

The recent meteoric rise in GLD has ushered in yet another volatility surge, which is just one more example of the positive correlation we tend to see with GLD and implied volatility. As mentioned in Gaming the Gold Bugs, these spikes are usually short lived and experience reversion to the mean once the mad dash for options subsides. Tack on the fact that IV30 is sitting at a hefty premium to 20HV (24% vs. 15%) and it's fair to say volatility sellers have a bit more edge at this point versus buyers.

So last time I mentioned using a 1x2 call spread to exploit the elevated implied volatility as well as place a mildly bearish bet. What about this go around? The big x-factor with current conditions is the fact that GLD has gone virtually parabolic, making it quite difficult to step in and fade the move. Since the 1x2 call spread involves selling naked calls, there can be considerable risk if the underlying rises too far. Though I was comfortable selling naked calls last go around, I'd be lying if I didn't admit the parabolic rise in GLD gives me pause.

To paint a better picture, think of it this way. Flip the chart of GLD upside down and pretend it just dropped about 15-20 days in a row- a veritable falling knife. Would you be comfortable selling some naked puts? If the huge drop in price gives you a bit of pause, then you understand where I'm coming from.

With that being said, let's explore a 1x2 call spread just for kicks. Suppose we buy the Dec 119 call and sell two 121 calls for a net credit of $.25. Consider the risk graphs:
[Source: EduTrader]
If we wanted to make more of a bearish bet, we could potentially use lower strikes (such as 117-119), sell additional naked upside calls, or simply settle with bear call spread.


Anonymous said...

great Post! I appreciate you taking the time to blog these things. makes trading life more enjoyable.

-big fan

Tyler Craig said...

Many Thanks. It's an enjoyable process.


Great chart