What Options Are Telling Us About Gold And Silver

Includes: GLD, SLV
by: Richard Bloch

Sometimes the options markets offer clues about the market’s “mood." Right now, when it comes to gold and silver, the mood isn’t so glum as it was during 2011.

For clues, I took a look at open interest on both the SPDR Gold Trust (NYSEARCA:GLD) and the iShares Silver Trust (NYSEARCA:SLV).

For SLV, the number of open contracts open surged into earlier 2011 then fell rather rapidly along with the metal itself.

As for GLD, the open interest has been a lot steadier.

You can see that the red line representing puts seemed to drop off in the second half of 2011. How much? Well the put/call ratio shows that a bit more clearly.

The put/call ratio has fallen to its lowest level in two years for GLD, which I interpret as a bullish sign – or at the very least a non-bearish sign.

For silver, the put/call ratio has also dropped – not as low as in early 2010, but at fairly low levels nonetheless.

As for the ETFs themselves, the size of each trust shows that there’s about 15% less silver in the SLV Trust than there was at the beginning of 2011. Holding in the GLD ETF have been a lot steadier, although what looks like a tiny drop in GLD holdings in the last quarter of 2011 represents about 2 million ounces of gold.

Precious Metal Headwinds

One issue with the market for both gold and silver is the debacle caused by the MF Global fiasco. There was certainly significant net selling as futures traders were left scrambling to move their existing positions to new firms.

The European debt crisis isn’t helping matters much, as the dollar has gained significant strength against the euro – and that’s not great for gold and silver denominated in U.S. dollars.

But the options market offers another clue that these markets are settling down. Implied volatility dropped a lot in the last quarter of 2011.

Here’s a look at the 90-day indexed implied volatility for both ETFs. This represents the relative pricing of options on these ETFs – essentially traders’ predictions for future price movement.

The dashed red lines are my attempt to draw some sort of a trend line encompassing the last two years. Based on this I would say that SLV options start to get “cheap” if implied volatility gets below 40%, while GLD options become attractive at IV levels of below 20%.

I’m long both ETFs and from what I see here, I see no reason to make any changes to my GLD and SLV positions.

Disclosure: I am long GLD, SLV.