Of all of the commodities on the board, there is none more emotionally charged than gold. People buy a contract of sugar because demand is high and/or supply is low and they think that will pull prices higher. People buy a contract of gold for many, many, many different reasons. And rarely is it directly related to supply and demand.
For that reason, gold (and to a lesser extent, it's cousin silver) have to be approached differently than other commodities when selling options.
The problem with gold is, it doesn't trade like other commodities. People buy and sell gold because of fear. They use it as a way to voice political opinions or personal beliefs. They trade it in reaction to Fed announcements or economic reports. In fact, you can view gold as a market that accurately reflects the overall emotions of the investment community.
Gold is likely the most emotionally-driven commodity on the board.
If you are selling puts or calls in the soybean market, you look at the supply/demand report for soybeans. Not so in gold.
Gold is a much more Macro market. So, when trading gold, the bigger picture is what is most important.
Nonetheless, if you are selling commodities options, I do recommend that you not overlook the premium available in precious metals. Different does not mean bad. It is an excellent diversifier and is uncorrelated to most other commodities. Furthermore, the huge public interest in gold makes the options not only very liquid, but often overpriced.
Remember, one of the key lessons of "The Complete Guide to Option Selling": When the public gets heavily involved, there are opportunities to take their money. I hope that doesn't sound heartless, but commodities are a zero sum game. For every winner, there is a loser. If you're going to play, you might as well not be shy about winning.
Gold: The Long Story Made Short
There are entire books written on trading gold, so we are not going to attempt to outline all of the factors that could affect gold prices in the next 90 days.
However, the short story is this:
The latest Comments from this week's FOMC meetings took a more bullish tone towards the US economy and a more cautious tone towards inflation. This in turn, makes it less likely that any type of "QE3" program (Money Printing) will happen any time soon. The Fed went as far as to say that fiscal tightening may even begin to occur in 2013. Easing, currency printing, and other tools to spur economic growth are bullish for gold. The more dollars printed means it takes more of them to buy an ounce of gold (the commodity most directly linked to currency fluctuations). This is why gold has been rallying for several years now. Consequently, a more upbeat outlook for the economy means less or none these tools being used. This is bearish for gold and the reason prices fell last week.
August 2012 Gold
Time to sell calls or is strangling the better strategy?
Sell it all? Not so Fast
So sell the still grossly inflated calls right? Yes, maybe. But that might not be your best overall play.
The strange thing about this economic and stock market recovery is, few people seem willing to buy into it all the way. Despite what the monthly numbers are saying, despite the raging bull market in stocks, the tone in the investment world remains one of wariness. Perhaps it's what we've all witnessed in the markets over the last 4 years. Perhaps it is all of those number crunchers out there telling us that Europe and the US are merely using smoke and mirrors to delay an inevitable crash. Perhaps, it is a vague feeling of distrust from the investment class of the current administration in Washington.
Either way, don't expect investors to begin dumping their gold in mass just because the Fed got a little more upbeat on the economy. Prices have to adjust to a lowered expectation of QE3. But there is still too much angst out there to expect gold prices to plummet in the longer term.
Conclusion and Strategy
For those of you who watch our video updates on the blog, this might sound like a broken record. However, selling deep out of the money strangles in gold continues to be one of the strategies I would recommend to an option seller. We've been writing these for clients for months and I continue to see opportunity there, especially after this week's price adjustment. I continue to see the gold market as one of those wells from which option writers can bucket premium over at least the next 30-60 days.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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