Order Of Magnitude

Gold as an investment is being tossed around more and more.  Gold is near all time highs, and as of this writing is over $1000USD / oz.  Although it hasn't yet closed over that level.  If you pull pack and take a look at a longer timeframe of the continuous contract, most can pick out a multi-part inverse head and shoulder pattern.  We always recommend a part of your portfolio be set in actual assets, and precious metals are easy to get and rather value dense.  This time however, we're looking to use the SPDR Gold Shares ETF, which trades under GLD in New York.  They shave off 0.4% every year for doing all the paperwork, and are one of the ETFs with the best correlation to actual spot gold prices.

We're never ones to just rush out and buy something, because it looks good.  Right now Gold, as well as the ETF, are at a critical point.

Support and Resistance for GLD

The power of the current trend is undeniable, and we've been in this confluence of resistance before.  If the H&S pattern holds, a measured move to $1200 within the measure of the head of the pattern (~ $700) to the resistant neckline (~ $1000).  Although, if it turns out to be a false signal, there isn't a lot of proven support until under the $850 level.  The whole world is watching, and the speculators are speculating, so we decided to check out the pricing in the options.

GLD Call Premium

GLD Put Premium

The curve is more natural than the graph depicts because the strikes start moving up by $5 instead of $1 at $100.  We want to be prepared for a move in either direction.  We thought we would explore selling covered at the money calls.

100 shares of GLD ~ $9870

1 GLD Jan 2010 $99 Call ~ $620

This means that our cost of out pocket is $9260 (including about $10 in fees).  If we die tomorrow and the stock closes higher than $99, we'll net about 6.2% on expiration day, which is 126 days away.  Annualized this play works out to 12.7%.

If you'd rather try to bring in the expiration date, to more rapidly see time decay in action.  Selling a GLD Oct 2009 $99 (~$280), you'd be $9600 out of pocket (again including about $10 in fees) and a close above that would result in about a 3.1% profit over 35 days.  Annualized the October play works out to 36%.

In either case, you have no downside protection, and your profits are capped.  Our plan is to watch, and if the price of GLD breaks down below $90, we'll take our loss and exit the position.  If the price of gold manages to hold, or remains range bound, we'll let time decay work it's magic, and roll our short call contract forward a few months closer to December.  If the price breaks out and continues to trend upwards, we will wait until the premium of the contract erodes to about 2%, then close it and short another at-the-money covered call.

Tweet This Post

I mentioned earlier that some rules were broken, which resulted in larger than usual losses.  At the time, adding another rule to the list, seemed like an excellent idea.  At the time, I had 8 trading rules, and adding another brought the total to 9.  This number is outside the total that the average human mind can keep in context at one time.  As a result, I've reworked the rules down to a manageable 5.

Tweet This Post