The June Gold Contract closed at 1294.90 on Friday after trading a dollar shy of the magical $1300 level. Since last Friday’s close, Gold has risen $61.20 or 4.96%. While it’s too early to say if Gold will have a difficult time breaching the $1300 level, it is a good opportunity to examine the market. In a similar pattern, also this week, the June E-mini S&P Contract breached the 2100 level and traded as high as 2105 before settling at 2097.25 on Wednesday. The overbought conditions and several external factors including earnings, Japan and conjecture about Great Britain helped drive Stocks down on Thursday and Friday. On Friday, the E-mini S&P closed at 2060.25, recovering 14.50 points from its low of the day. The Relative Strength Index is a measurement of overbought and oversold market conditions. It is one factor tool that a trader can use to determine whether a market is overbought. In the case of Gold, the Relative Strength Index indicates an overbought market.
If you believe that Friday’s Gold movement was a bit overdone, then the question is how to capitalize on your market bias. Trading Options on Gold Futures provides leverage and liquidity to establish an Options Trading Position to meet your goals. The difficult part is finding the right strategy which provides an appropriate risk/reward ratio. Many people shy away from Gold Futures in favor of numerous Gold ETFs and Hybrids, unfortunately the transparency in many of those markets is not very good. Often times, whether trading Gold, Silver or Crude Oil, traders will find a proxy for trading the Futures Contract, but these proxies can be much less cost effective to trade than the standard Futures Contract. As a measure of comparison, evaluate the liquidity of the underlying contract by Subtracting the Bid Price from the Ask Price and dividing the result into the Ask Price. This will give you a Liquidity Percentage. The lower the percentage, the better the value. Keep in mind that this is only used to evaluate out-of-the money options.
Unfortunately, the more poorly you are capitalized, it is frequently more difficult participate in the larger, more liquid contracts. If you can find the right market, and in this case we are talking about Gold and the E-mini S&P it is much easier to create a position that meets your needs. The Table below provides Prices and Implied Volatilities for certain Strike Prices in both Gold and the E-mini S&P. It’s easy to see that the Implied Volatility Skew for Gold is much different than the E-mini S&P. In the Gold Market, people are much more willing to pay comparatively high prices for the Calls compared to the Puts. In the S&P, the reverse is true and the Implied Volatility is Skewed to greater Implied Volatility the farther the Put is away from the money. These Skews provide longer term options traders with the ability to establish positions that can give them a theoretical advantage. The link provides further information about Implied Volatility, the Skew and certain positions which are structured to be advantageous to those with a market bias. If you want to get Short Gold, and are willing to structure a position that has unlimited risk, the Table below has the details. You could Sell the 1350 Calls at 8.80. The Strike Price is 54.90 from the price of the last trade. In addition, you could Buy the 1250 Put for 7.70. This Option is 45.10 away from the current trading price. Not only does the Call have a higher Implied Volatility and Price than the Put, but it is trading farther away from the current price. This Short Fence is just one of the strategies that take advantage of the Structure of the Implied Volatility Skew. See if you can find similar advantages for the E-mini S&P shown in the Table below.
Markets tend to trade around a mean. In only January June Gold traded as low as $1061. It had not traded that low in quite a while. On February 11th, the E-mini S&P traded around the 1800 level. Commodity markets fluctuate tremendously, but as a zero sum game, they tend to revert to the mean. Over the long-term the companies that make up the S&P cannot be considered commodities, they respond to the economics of their business. In the short-term, however, the S&P can trade just like a commodity and as such one must be quite wary of overbought and oversold conditions in all markets.
OPTIONS TRADING INVOLVES SIGNIFICANT RISK AND IS NOT SUITABLE FOR EVERY INVESTOR. THE INFORMATION IS OBTAINED FROM SOURCES BELIEVED TO BE RELIABLE, BUT IS IN NO WAY GUARANTEED. PAST RESULTS ARE NOT INDICATIVE OF FUTURE RESULTS.