Many investors believe a well diversified portfolio will have a small portion of assets allocated to gold. Probably the most common way retail investors gain exposure to gold is through a gold ETF such as GLD. Alternatively, some investors gain exposure to gold by owning individual gold mining stocks, or perhaps a gold miner ETF such as GDX. Another approach to gain exposure to gold is via options on either of these two entities. An options-based approach can achieve the objective of having exposure to gold while reducing the capital required to hold the position.
A few suggested option positions are described below, but first a few assumptions:
- The biggest reason for having gold in a portfolio is to have something that goes up (hopefully a lot) if/when some sort of bad news related to geo-politics, monetary policy, market hiccups, etc. drives other markets down. Hence, the objective of owning gold is likely not to grind out a few percentage point gain over the mid term, but rather have a position that profits if gold spikes meaningfully higher. Hence option positions which give up some small gains on small moves in price, while retaining unlimited upside might be worthy of consideration.
- Gold and the gold miners should trade in a correlated manner. This seems to make common sense, and is generally supported by history. However, there is no guarantee that this relationship will hold perfectly true in the short term.
- Since there are really no fundamentals for gold (i.e. revenue/earnings), it is likely that market participants rely more heavily on technical analysis to make trading decisions. Hence extra care should be taken to consider technical indicators when placing trades in these stocks.
Here are three option trades that provide gold exposure with a different risk reward profile than simply buying gold.
- Risk reversal in gold - One options-based approach that gains exposure to large upward movement in gold while lowering the amount of capital invested is a risk reversal. For example, with GLD selling at about $164, an investor could sell the January 13 $155 put and use these proceeds to buy the January 13 $176 call. This trade can be established for essentially no out of pocket cash. However, it does commit the investor to buy GLD if it pulls back to $155. A level which seems to have some support on the charts. If this position is cash secured, the investor risks $15,500. About 6% less at risk than purchasing GLD at $176. An investor does not start accumulating losses until GLD falls below $155 or 6% from the current price. Conversely, an investor does not start to make money until GLD rises over $176. This is a resistance level on the chart, but if macro events start to push the price of gold higher, momentum traders might push it substantially higher than this level. The $21 range between $155 and $176 has essentially no impact on the portfolio.
- Risk reversal in gold miners and gold - A similar approach can be done mixing the two highly correlated entities of the gold miners and gold. For example, recently with gold trading near $160, I was able to sell 3 Dec $40 puts in GDX and buy 1 Dec $165 call in GLD for a net credit of a modest $107. Assuming the gold miners and gold trade in a somewhat correlated manner, this trade has a similar potential outcome as the trade described above. However, since gold miners are considered more risky by the market, options in GDX have higher implied volatility and price. Hence this trade only required an investor to put $12,000 in capital at risk and lowers the bar to when an investor starts accumulating gains. I've successfully used this strategy several times over the past as originally described in this seekingalpha.com article.
- Spreads - If an investor desires to use even less capital to establish these types of positions, that can be achieved by spreading off the put side of the above trades by buying a further out of the money put. For example: in the first trade above buying the GLD Jan $140 put and in the second trade buying the GDX Dec $35 put. Establishing this position will require either a little cash out of pocket and/or moving the strike of the call bought up a few dollars, but does lower the capital risked on this trade substantially.
Thinking about holding these option positions until expiration is the easiest way to envision how these positions accomplish the objective of providing some gold exposure to a portfolio. However, as with most option trades, opportunities will likely present themselves over the life of the trade to manage the position by rolling the position further out to gain time for the trade to mature and/or harvesting smaller gains or cutting losses as the gold market evolves. Hence the option positions really provide even more flexibility than simply holding the stocks, and could be worthy of consideration by most investors.
Disclosure: I am long GLD, GDX. 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.
Additional disclosure: This posting is for informational, educational and entertainment purposes only and should not be considered investment advice.