Thursday, November 14, 2013

Selling Options Premium in Gold (GLD)

Gold has been a hot topic of discussion among investors & traders lately, supported by media frenzy over how gold as an asset class has done this year . We all have our thoughts on why gold prices tanked and continue to opine on how gold will perform moving forward . Increased volatility in gold prices stretched options premiums as option markets priced in sharp downside moves in gold even though gold is not moving at levels seen during April this year . For those who like to trade options in Gold, you have to put into context how gold has moved historically , how are options currently priced  and take advantage of opportunities which exist.

For an options trader it is extremely critical to have an opinion on direction of volatility in addition to the price of underlying. Chart  displays the realized volatility in gold over a 30 day period for the last  4 years. 30 day realized (historical) volatility currently stands at 16.0%  and it has ranged between 7.5% to 37 % putting it in 50 th percentile.

Let's see how Implied volatility levels are priced across the tenor and what I expect  values of implied vol should be.  We can see front month options are priced fairly and second month ( IV60) options are  priced cheaper than expected- this can be explained by holiday theta effect- as theta during holidays gets decayed out of option prices. What we lack into our current analysis  is our view point on realized volatility. We can clearly see it spiked up-to 36.8% level before it started its slow descent down.
Gold was down almost down by 9.5% on April 14 and since then has been only down by 6.5% . Speed at which gold moved subsided dramatically which is reflected through declining realized volatility levels. My take is gold's realized volatility will continue to decline and will hit single digit levels.This is supported by the fact that market is not expecting QE taper by March now in addition to declining inflation expectation in developed economies.

As I wrote in my previous post, I expect gold prices to continue tracking the price patterns gold exhibited during late 70's and early 80's - making me short term bearish on gold.  I expect gold prices to move down close to 120  with 116 as my limit and upside capped close to 131'ish level. With opinion on price and volatility in place - my inclination is to create a trade structure which is short delta, short gamma and short vega. Positive theta is  a compensation which I am getting paid for being short gamma.

Buying  Feb/March ATM or slightly OTM put calendars financed by Selling Feb Call credit spreads ( in a ratio) offers balanced greeks & good risk reward.   

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