Wednesday, November 4, 2009

Gaming the Gold Bugs

Given the recent surge in gold prices, we've seen an up tick in chatter, price prognostications, and volatility forecasting concerning the precious metal. So... why not join the fray and give a few thoughts of my own?

Over the past few months, GLD has exhibited low levels of volatility with 21 day HV remaining steady around the 14 to 16% range. However, each time we've seen GLD's price breakout in continuation of its uptrend there has been a veritable flock to options which has caused a spike in implied volatility. The most recent two spikes have turned out to be short lived events that provided an opportunity for volatility sellers to exploit mean reversion. If you believe that trend will continue, you may consider entering short vol strategies to play the current IV spike.

[Source: Livevol Pro]

Though there are a plethora of potential volatility plays to choose from, let's focus on a mildly bullish one, the call ratio spread.

Long (1) November 109 call @ $1.30 (IV = 22%)
Short (2) November 111 call @ $.78 (IV = 23%)
Net Credit = $.26
[Source: EduTrader]

The trade benefits from a decline in implied volatility as well as time decay. Because it involves selling a naked call, there is upside risk if the stock rises too much, so you obviously need to make sure you're comfortable selling naked calls.

Here's a potential variation that brings in more credit, while increasing upside risk.
Long (1) November 109 call @ $1.30 (IV = 22%)
Short (2) November 111 call @ $.78 (IV = 23%)
Short (1) November 113 call @ $.50 (IV = 24%)
Net Credit = $.76

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