Trading gold volatility with options

Gold had a busy time last week, it opened at $1,215.69 an ounce last Monday to then rally to $1242.93 on Tuesday, and it then tested a low of $1,208.88 on Friday. The performance of this shiny metal has been subdued over the past weeks compared to the beginning of the year. From January 4th it jumped nearly 19% in the space of 6 weeks, when in it touched $1,263.63. Since then it tested a new most recent high on March 10th at $1,273.29 but has been trading in a zig zag pattern to the downside.

Gold price benefitted from the stock market sell‐off that hit exchanges globally at the beginning of the year. As the precious metal is considered a safe haven it found renewed bullish momentum to buck its multi‐year long bear trend. Dovish talk from the Federal Reserve then helped keep the momentum going. More recently however, the stock market has begun to perform well on the back of expectations of a slower pace in the Federal Reserve’s tightening of monetary policy. The stock market rally has softened the strength of the rally in Gold, and further positive performance in stocks may weigh on Gold price.

The long‐term bear trend that had been afflicting Gold was mainly driven by supply surplus created during the prolonged rally that took price to levels just short of $2,000 an ounce. Last year, the World Gold Council Reports that supply increased by its slowest rate since 2008, at 1%. However, demand was flat for the full year of 2015, but the last quarter showed an increase in demand of 4% year‐on‐year. Central banks bought 33 tons and investment managers bought another 25 tons in the 4th quarter of 2015 alone.

Negative interest rates being pursued in major economies such as Europe and Japan may give this metal renewed appeal, as traditional investments such as bonds offer ever smaller yields. Nevertheless, Gold price may continue falling until it finds renewed support.

If you think the price of Gold will rally over the next week then you may buy a Call option which gives you the right to buy Gold at a pre‐set price (strike) on a pre‐set date (expiry) and for a specific amount.

The screenshot below shows a Gold Call option with a $1215.45 strike, expiry 7 days and for 10 ounces would cost $124.43, which would also be the maximum risk.

This screenshot shows the profit and loss profile for the above Gold Call option, just click the Scenarios button.

On the other hand, if you think the price of Gold will fall over the next week then you may buy a Put option which gives you the right to sell Gold at a specified strike, expiry and amount.

The screenshot below shows a Gold Put option with $1215.52 strike, expiry 7 days and for 10 ounces would cost $123.85, which would also be the maximum risk.

This screenshot shows the profit and loss profile of the above Gold Put option.