What are experts recommending when it comes to gold options? Here’s one view of what the upcoming FOMC meeting will mean to the price of gold and to the positions they will be taking.
As a reminder, all of our trading recommendations are based on options traded on US markets. Therefore when considering gold we trade options on GLD. We do not trade gold mining companies (and have rarely touched the mining stocks since May 2008) or options on gold mining companies for reasons discussed in our previous article, “Are Gold Stocks The Real Barbarous Relic? – 11 Jul 2011”.
We are maintaining a moderate long position on GLD through the FOMC meeting. Our exposure is however significantly lower than it was in the run from $1600 to $1800 when we felt that the risk-reward was far more skewed to the upside than it is at present. Nonetheless we maintain a sizeable long bias and still expect gold prices to reach $2000 in 2011, but most likely within the next month. Our reluctance to take a more aggressive position is not reflective of a lack of conviction that gold will reach $2000, but more due to our view that risk looks more symmetric than it did a couple of months ago.Our plan for after the FOMC meeting will be largely dictated by the language in the statement and the behaviour of US real interest rates in the weeks following. An exceptionally accommodative statement coupled with significantly declining US real rates would likely see us increasing our gold exposure. However an announcement of easing that is within a reasonable range of current market expectations will not cause us to increase our gold exposure. In fact a scenario where the statement is more accommodative that expected, but US real rates are rising would cause us to reduce our gold exposure. Rising US real rates and rising gold prices would see us selling into gold’s strength, as we view US real rates as the lead indicator here.
If a situation of increasing US real rates and rising gold prices persists and we have exited our long positions then we would be considering a short bias. We are not comfortable with outright aggressive short positions on gold due to the significant event risk, but we would be open to selling call spreads into such a market. These limited risk trades carry positive Theta and would look particularly attractive if near term calls are heavily bid and we see a backwardation of the volatility curve. Further discussion of the recent examples of backwardation in the gold volatility curve can be found in our previous article, “The Market Dynamics That Sent Gold Past $1800 – 15th August 2011”. A market with a vol curve in backwardation and skewed heavily towards calls is prime for selling call premium in our opinion, since both are symptomatic of a frothy market packed with speculative longs. Such a market could occur in the next month or so.
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