Gold Panic and How to Trade It

• stevenplace
• September 26th, 2011

Gold ($GLD) Traded significantly lower on Friday, finishing off what some would call a volatile blow off top, follwed by a failed breakout:

This marks the finishing of a multi-month topping pattern, which leads me to believe that the trend has changed, at least in the short term.

What was the main driver for $GLD prices to drop so hard? Essentially, the market was expecting something out of the Federal Reserve that it did not get. The fact that many were anticipating a continuation in precious metals after the Fed announcment led to a roach-motel exit out of the trade.

The best thing for gold bugs here is a multi-month consolidation, then a failed breakdown that finds aggressive buyers.

But with this large move in $GLD, the options market presents us with a very interesting opportunity. The term structure of $GLD options have seen a statistically significant move:

The yellow shaded area is the chart to watch. This shows us that the Implied Volatility on a 30 day basis is much higher compared to the 60 day reading. What gives?

Implied volatility is a function of supply and demand in the options, and is directly related to the perception of risk.

In this particular scenario, the perceived risk is much higher in the “right now” market compared to the “just around the corner” market. This has been justified by the near term price action, but the current market may be due for some reversion with respect to this relationship.

The trade here? Focus on trades where you can sell front month and buy next month. There are a variety of ways to do this: calendars, diagonals, and the like. Multiple permutations can lead to different directional exposure, so you can be long, short, or neutral. Either way, when trading options you can profit in any environment.

Want to learn how to trade options better? Want to profit no matter where the market is headed? Check out OptionFu, my options training course.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

blog comments powered by Disqus