Gold Miners Head To The Moon

| About: Direxion Daily (NUGT)
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Since we posted a hedge for NUGT on April 20th, that 3x gold miners ETF has shot up another 41% in nine days.

We look at the current status of the hedge and the gain an investor could make if he exited now.

We also discuss courses of action for hedged NUGT longs, whether they remain bullish on the ETF over the next several months or not.

Gold Miners Rocket Higher

Screen Capture from the Jonathan Coulton Project

Merry Christmas, from Chiron Beta Prime,

Where we're working in a mine for our robot overlords.

Did I say overlords? I meant protectors. - Jonathan Coulton

On April 20th, we wrote about hedging the Direxion Daily Gold Miners Bull 3X ETF (NYSEARCA:NUGT), which had been on a tear. Nine days later, NUGT was up another 41%.

NUGT Chart via YCharts

In a couple of recent articles (Amazon: Disadvantage Einhorn, Facebook Rewards Cautious Investors Less), we looked at what happened to hedges on Amazon (NASDAQ:AMZN) and Facebook (NASDAQ:FB), respectively, when those stocks shot up. NUGT is different in a couple of interesting ways. As a triple-levered ETF, it's a lot more volatile, and unlike Facebook and Amazon, NUGT has shot up so high that the call leg of its collar is in-the-money now. Let's take a look at our April 20th hedge on it, the status of it as of Friday's close, and what hedged longs should consider going forward.

Recapping Our April 20th NUGT Hedge

As of April 20th's close, this was the optimal collar to hedge 400 shares of NUGT against a greater-than-15% drop by mid-September while not capping an investor's upside at less than 30% by the end of that time period (the screen capture below comes from the Portfolio Armor iOS app).

A few notes about this hedge:

  • We used a 30% cap there because that was the potential return Portfolio Armor's website calculated for NUGT on April 20th. As of April 29th, the site's updated potential return for the ETF was 9%.
  • This hedge had a negative cost, meaning an investor opening it would have collected about $680 more from selling the call leg than he paid for the put leg, and amount equal to about 2% of his position value.
  • Although the cap was designed to allow the investor to gain as much as 30% (taking into account the 2% negative hedging cost, 32%) by mid-September, when the underlying spikes earlier, the time value of the call leg can sharply reduce any gains from exiting early, as we'll see below.

Here's an updated quote on the put leg as of Friday's close:

And here is an updated quote on the call leg:

How That Hedge Reacted To NUGT's 41% Gain

NUGT closed at $84.40 on Wednesday, April 20th. A shareholder who owned 400 shares of it and hedged with the collar above then had $33,760 in NUGT shares plus $7,520 in puts, and if he wanted to buy-to-close his short call position, he would have needed to pay $8,200 to do that. So, his net hedged position value on April 20th was ($33,760 + $7,520) - $8,200 = $33,080.

NUGT closed at $119.07 on Friday, April 29th, up 41% from its closing price on April 20th. The investor's shares were worth $47,628 as of 4/29, his put options were worth $5,160, and if he wanted to close out the short call leg of his collar, it would have cost him about $16,000 to do so (because the call option didn't trade on Friday, we based that estimate on the midpoint of its bid-ask spread rather than its last price). So, ($47,682 + $5,160) - $16,000 = $36,842. $36,842 represents a 11.4% gain from $33,080.

Cost Of Exiting Early

So, although NUGT was up by 41% at the time of the calculations above, if the investor hedged with this collar wanted to exit his position on Friday, his gain would have been limited to 11.4%.

What Now?

If you're hedged with this collar, and confident NUGT will still be above $110 by mid-September, you can hold steady. If that happens, you'll be able to exit close to the hedge's expiration for a gain of about 32%. If you're not confident NUGT will be above $110 in September, then you can consider exiting earlier.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.