Best of the Week
Most Popular
1. Stock Markets and the History Chart of the End of the World (With Presidential Cycles) - 28th Aug 20
2.Google, Apple, Amazon, Facebook... AI Tech Stocks Buying Levels and Valuations Q3 2020 - 31st Aug 20
3.The Inflation Mega-trend is Going Hyper! - 11th Sep 20
4.Is this the End of Capitalism? - 13th Sep 20
5.What's Driving Gold, Silver and What's Next? - 3rd Sep 20
6.QE4EVER! - 9th Sep 20
7.Gold Price Trend Forecast Analysis - Part1 - 7th Sep 20
8.The Fed May “Cause” The Next Stock Market Crash - 3rd Sep 20
9.Bitcoin Price Crash - You Will be Suprised What Happens Next - 7th Sep 20
10.NVIDIA Stock Price Soars on RTX 3000 Cornering the GPU Market for next 2 years! - 3rd Sep 20
Last 7 days
US Housing Market House Prices Momentum Analysis - 26th Feb 21
FOMC Minutes Disappoint Gold Bulls - 26th Feb 21
Kiss of Life for Gold - 26th Feb 21
Congress May Increase The Moral Hazard Building In The Stock Market - 26th Feb 21
The “Oil Of The Future” Is Set To Soar In 2021 - 26th Feb 21
The Everything Stock Market Rally Continues - 25th Feb 21
Vaccine inequality: A new beginning or another missed opportunity? - 25th Feb 21
What's Next Move For Silver, Gold? Follow US Treasuries and Commodities To Find Out - 25th Feb 21
Warren Buffett Buys a Copper Stock! - 25th Feb 21
Work From Home Inflationary US House Prices BOOM! - 25th Feb 21
Man Takes First Steps Towards Colonising Mars - Nasa Perseverance Rover in Jezero Crater - 25th Feb 21
Musk, Bezos And Cook Are Rushing To Lock In New Lithium Supply - 25th Feb 21
US Debt and Yield Curve (Spread between 2 year and 10 year US bonds) - 24th Feb 21
Should You Buy a Landrover Discovery Sport in 2021? - 24th Feb 21
US Housing Market 2021 and the Inflation Mega-trend - QE4EVER! - 24th Feb 21
M&A Most Commonly Used Software - 24th Feb 21
Is More Stock Market Correction Needed? - 24th Feb 21
VUZE XR Camera 180 3D VR Example Footage Video Image quality - 24th Feb 21
How to Protect Your Positions From A Stock Market Sell-Off Using Options - 24th Feb 21
Why Isn’t Retail Demand for Silver Pushing Up Prices? - 24th Feb 21
2 Stocks That Could Win Big In The Trillion Dollar Battery War - 24th Feb 21
US Economic Trends - GDP, Inflation and Unemployment Impact on House Prices 2021 - 23rd Feb 21
Why the Sky Is Not Falling in Precious Metals - 23rd Feb 21
7 Things Every Businessman Should Know - 23rd Feb 21
For Stocks, has the “Rational Bubble” Popped? - 23rd Feb 21
Will Biden Overheat the Economy and Gold? - 23rd Feb 21
Precious Metals Under Seige? - 23rd Feb 21
US House Prices Trend Forecast Review - 23rd Feb 21
Lithium Prices Soar As Tesla, Apple And Google Fight For Supply - 23rd Feb 21
Stock Markets Discounting Post Covid Economic Boom - 22nd Feb 21
Economics Is Why Vaccination Is So Hard - 22nd Feb 21
Pivotal Session In Stocks Bull Bear Battle - 22nd Feb 21
Gold’s Downtrend: Is This Just the Beginning? - 22nd Feb 21
The Most Exciting Commodities Play Of 2021? - 22nd Feb 21
How to Test NEW and Used GPU, and Benchmark to Make sure it is Working Properly - 22nd Feb 21
US House Prices Vaccinations Indicator - 21st Feb 21
S&P 500 Correction – No Need to Hold Onto Your Hat - 21st Feb 21
Gold Setting Up Major Bottom So Could We See A Breakout Rally Begin Soon? - 21st Feb 21
Owning Real Assets Amid Surreal Financial Markets - 21st Feb 21
Great Investment Ideas For 2021 - 21st Feb 21
US House Prices Momentum Analysis - 20th Feb 21
The Most Important Chart in Housing Right Now - 20th Feb 21
Gold Is the Ultimate Reserve Asset - 20th Feb 21
Is That the S&P 500 And Gold Correction Finally? - 20th Feb 21
Technical Analysis of EUR/USD - 20th Feb 21
The Stock Market Big Picture - 19th Feb 21
Could Silver "Do a Palladium"? - 19th Feb 21
Three More Reasons We Love To Trade Options! - 19th Feb 21
Here’s What’s Eating Away at Gold - 19th Feb 21
Stock Market March Melt-Up Madness - 19th Feb 21
Land Rover Discovery Sport Extreme Ice and Snow vs Windscreen Wipers Test - 19th Feb 21
Real Reason Why Black and Asian BAME are NOT Getting Vaccinated - NHS Covid-19 Vaccinations - 19th Feb 21
New BNPL Regulations Leave Zilch Leading the Way - 19th Feb 21
Work From Home Inflationary House Prices BOOM! - 18th Feb 21
Why This "Excellent" Stock Market Indicator Should Be on Your Radar Screen Now - 18th Feb 21
The Commodity Cycle - 18th Feb 21
Silver Backwardation and Other Evidence of a Silver Supply Squeeze - 18th Feb 21
Why I’m Avoiding These “Bottle Rocket” Stocks Like GameStop - 18th Feb 21
S&P 500 Correction Delayed Again While Silver Runs - 18th Feb 21
Silver Prices Are About to Explode as Stars are Lining up Like Never Before! - 18th Feb 21
Cannabis, Alternative Agra, Mushrooms, and Cryptos – Everything ALT is HOT - 18th Feb 21
Crypto Mining Craze, How We Mined 6 Bitcoins with a PS4 Gaming Console - 18th Feb 21
Stock Market Trend Forecasts Analysis Review - 17th Feb 21
Vaccine Nationalism Is a Multilateral, Neocolonial Failure - 17th Feb 21
First year of a Stocks bull market, or End of a Bubble? - 17th Feb 21
5 Reasons Why People Prefer to Trade Options Over Stocks - 17th Feb 21
The Gold & Gold Stock Corrections Are Normal - 17th Feb 21
WARNING Oculus Quest 2 Update v25 BROKE My VR Headset! - 17th Feb 21
UK Covid-19 Parks PACKED During Lockdown Despite "Stay at Home" Message - Endcliffe Park Sheffield - 17th Feb 21
How to Invest in ETFs in the UK - 17th Feb 21
Real Reason Why Black and Asian Ethnic minorities are NOT Getting Vaccinated - NHS Covid-19 Vaccinations - 16th Feb 21
Gold / Silver: What This "Large Non-Confirmation" May Mean - 16th Feb 21
Major Optimism for Platinum, Silver, and Copper - 16th Feb 21
S&P 500 Correction Looming, Just as in Gold – Or Not? - 16th Feb 21
Stock Market Last pull-back before intermediate top? - 16th Feb 21
GAMESTOP MANIA BUBBLE BURSTS! Investing Newbs Pump and Dump Roller coaster Ride - 16th Feb 21
Thinking About Starting to Trade This Year? Here Are Some Things to Keep in Mind - 16th Feb 21
US House Prices Real Estate Trend Forecast Review - 15th Feb 21
Will Tesla Charge Gold With Energy? - 15th Feb 21
Feeling the Growing Heat and Tensions in Stocks? - 15th Feb 21
Morgan Stanley Warns Gasoline Industry Is About to Become Totally Worthless - 15th Feb 21
Debts Lift Gold - Precious Metal Prices Will Rise on a Deluge of Red Ink - 15th Feb 21
Platinum Begins Big Breakout Rally - 15th Feb 21
How to Change Car Battery Without Losing Power, Memory, Radio Code Settings - 15th Feb 21
Five reasons why a financial advisor can make a big difference to your small business - 15th Feb 21

Market Oracle FREE Newsletter

FIRST ACCESS to Nadeem Walayat’s Analysis and Trend Forecasts

Trading Gold Options with Long-term Calendar Spreads

Commodities / Gold and Silver 2010 Nov 12, 2010 - 01:04 PM GMT

By: J_W_Jones


Best Financial Markets Analysis ArticleAt this point anyone following financial markets realizes that current market conditions are directly impacted by the movement of the U.S. dollar. Recently the dollar has shown strength and could potentially be putting in an intermediate or potentially longer term bottom. At this point it is a fool’s game making predictions, but the current Dollar Index daily chart shows that the price is above the 20 day simple moving average which is generally a bullish signal. The daily chart of the Dollar Index (.DXY) can be seen below.

My most recent article discussed using a short term calendar spread to capture time premium of the gold ETF GLD’s weekly options. While I do not recommend that traders place trades based on my articles, I would like to point out that the most recent GLD calendar trade I posited would have produced a significant double digit gain as of the opening bell Friday. I do not mention this to boast, but simply to point out the power of calendar spreads using weekly options and their rapid time (Theta) decay.

The horizontal volatility skew of the weekly options places the short-term calendar strategy at the top of my list based on current market conditions. By this I mean that the implied volatility of the weekly options since their recent introduction has tended to be greater than that of the corresponding longer dated options. However, calendar spreads can be utilized in longer term trades as well as a cheaper surrogate for equity ownership.

Currently gold appears to be going through a pullback and possibly a major correction based on price action in the dollar and it could setup for a possible longer term entry in time. The weekly gold chart is listed below.

Traders that believe inflation will continue to rise dramatically over the next few years might consider the following long-term calendar spread versus outright equity ownership. The strategy is precisely the same as its proverbial cousin the short-term calendar spread, however the characteristics and risk profile is somewhat different due to volatility differences on longer dated option chains.

The strategy involves buying GLD leap (option that does not expire for 1-2 years or more) call contracts and regularly selling weekly call contracts against them. The process continues every week while the premium collected helps reduce the overall cost of longer dated GLD calls. The construction is fairly basic, however relatively deep in the money calls should be used for the long leap side of the construction. The weekly options to be sold against the long position will typically be at-the-money or even slightly out-of-the-money and the position will be classified as a diagonal calendar spread.

Since the longer dated calls are deep in the money and have a significant amount of time before they expire they are somewhat insulated against volatility and have a relatively low time decay risk. The sheer nature of option pricing enables the longer dated calls to withstand harsh volatility changes while providing the trader the ability to have similar price action as he/she would by owning GLD common stock outright. The primary advantage of utilizing options versus stock ownership is the reduced price of the option contract versus stock ownership.

As of the writing of this article, GLD in Friday’s pre-market action was trading around $136/share. An option trader could purchase a January 2012 125 Call contract based on Thursday’s close for $2,165 not including commissions. Purchasing 100 shares of GLD would cost an equity trader $13,600 or $6,800 if they were using a Reg T margin account. In either case, the long dated GLD leaps provide similar price action with reduced capital. For the price of 100 shares of GLD a trader could purchase 6 GLD January 2012 125 calls for 6x the exposure. However, as most astute traders will point out it is theoretically possible to lose the entire amount invested in the option contracts should gold have a major pullback in short order.

While this accusation is indeed correct, through the use of contingent stops based on GLD’s price this risk is mitigated to an equal amount of risk as an equity trader utilizing stops on GLD’s price. In the end, the risk is inherently the same setting aside time decay suffered by the long option, which early on in this trade will be next to nothing. Additionally, the trader will be selling weekly calls against the long dated GLD leaps to reduce the overall cost of the position allowing a trader the possibility of reaping additional upside.

The trade construction is as follows:

Buy 5 GLD Jan 2012 Leap Calls at the 120 strike for around $23.00

Sell 5 GLD November 2010 136 calls at the 135 strike for around $2.05

The profitability graph for the November expiration (Friday, November 19, 2010) is illustrated below:

It is important to recognize that the illustrated graph represents the first of 62 anticipated sales of weekly calls against these long options that will be available prior to the LEAP’s expiration.

The risk for this trade is twofold; the first risk occurs if price moves beyond the bounds of profitability. The second risk, volatility risk is not as obvious. One of the functional characteristics of LEAPS is that they are exquisitely sensitive to changes in volatility. It is for this reason we have chosen a deep in-the-money call to buy; remember that volatility changes only impact the time (extrinsic ) component of option premium and the deep in-the-money options have the least time premium embedded within their price.

Trade management includes exiting the trade if specific stop targets are hit, specific profit/loss targets on this trade are met, or violation of technical support or resistance. In order to understand this trade, the aspiring option trader needs to follow both price and volatility impacts that are respective of this trade’s construction. I suggest the trader journal not only the relevant prices of the underlying and its corresponding options, but also the implied volatility of each.

As with everything in life, there are no guarantees. However this trade harnesses the power of theta decay and capitalizes on one of the basic truths of life:  tomorrow there is one less day for all of us - the same can be said for option contracts.

If you would like to continue learning about the hidden potential options trading can provide please join my FREE Newsletter: 

 J.W. Jones is an independent options trader using multiple forms of analysis to guide his option trading strategies. Jones has an extensive background in portfolio analysis and analytics as well as risk analysis. J.W. strives to reach traders that are missing opportunities trading options and commits to writing content which is not only educational, but entertaining as well. Regular readers will develop the knowledge and skills to trade options competently over time. Jones focuses on writing spreads in situations where risk is clearly defined and high potential returns can be realized. 

This article is intended solely for information purposes. The opinions are those of the author only. Please conduct further research and consult your financial advisor before making any investment/trading decision. No responsibility can be accepted for losses that may result as a consequence of trading on the basis of this analysis.  

© 2005-2019 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.

Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules