How To Profit From Gold's Trading Range

| About: SPDR Gold (GLD)

SPDR Gold Shares (NYSEARCA:GLD) seeks to replicate the performance, net of expenses, of the price of gold bullion. Gold has been trading in a tight range over the last few weeks, and until we get a clear catalyst to push it higher or lower, I believe gold can stay in this range for the next few weeks.

How can we profit from this?

There are few ways to trade a stock within a trading range. Some of the most popular strategies are iron condors and calendar spreads. Which one is better in the current situation?

The CBOE Gold ETF Volatility Index, or Gold VIX, measures the market's expectation of 30-day volatility of gold prices by applying the VIX methodology to options on GLD. The CBOE Gold ETF Volatility Index (GVZ) is now trading below $14, which is an all-time low:

Click to enlarge images.

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An iron condor is a vega negative strategy, which benefits from a decrease in implied volatility (IV). The calendar spread is a vega positive strategy, which benefits from a increase in IV. With GLD IV at an all-time low, I can see the IV going only one way from here -- up.

Here is one possible trade to take advantage of the current situation, with GLD trading around 167.80:

  • Buy to open Jan. 18, 2013, 165 put
  • Sell to open Nov. 30, 2012, 165 put
  • Buy to open Jan. 18, 2013, 170 call
  • Sell to open Nov. 30, 2012, 170 call

The risk profile looks like this:

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How do we make money from the calendar spread?

The first way is the time decay. The idea is that the near-term option is losing value much faster than the back-month option. Sounds good, doesn't it? The problem is that the stock will not always act according to our plan. If the stock makes a significant move, the trade will start losing money.

The second way the calendar trade makes money is from an increase in the volatility in the far-month option, or a decrease in the volatility in the short-term option. If there is a rise in volatility, the option will gain value and be worth more money.

The plan is to roll the short options every week to the next week, as long as the stock remains between $165 and $170. The risk is that the stock moves outside the profit zone. In this case, we will have to make an adjustment. But the assumption is that if GLD starts to become volatile again, the IV of the options will increase and the value of the calendar will increase as well.

Disclosure: I own the double calendar described in the article. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Disclaimer: Please trade responsibly. Before making any trading decisions, make sure you understand what you are doing.