TUESDAY, APRIL 6, 2010
Going for a Gold Breakout
By STEVEN M. SEARS
Consider buying calls on SPDR Gold to capitalize on a rally.
AT ANY MOMENT, THE PRICE of gold reflects the economic fears of man.
When gold prices are high, man fears his economic future. This has been a common thought as gold prices have surged as the Federal Reserve printed money to end the credit crisis and rescue the financial system from collapse. When gold prices are low, or range-bound as they are now, it does not mean that man is less fearful, but rather that he is somewhat satiated in his fear of the future.
However, from time to time, gold's price, like fear, spikes for reasons that are more technical than emotional. Now, may be such a time, according to MKM Partners, an institutional brokerage firm in Greenwich, Conn., which is advising clients to buy call options to benefit from gold's expected advance.
MKM is telling clients to prepare for "a gold breakout" because technical analysis indicates the yellow metal is ready to rally, which would be a welcome relief to the world's gold bugs who have been frustrated since December when the yellow metal's price peaked. Since December, the primary proxy of gold, at least for equity investors, the SPDR Gold Trust (ticker: GLD), has mostly remained range-bound.
To benefit from gold's potential rally, Jim Strugger, MKM's derivatives strategist, is telling clients to buy SPDR Gold's May $113 calls to position for gold to break out above short-term resistance and test $1,164 an ounce before moving toward the 2009 high of $1,230 an ounce.
Strugger's trade monetizes the view of Katie Stockton, MKM's technical analyst, who told clients Monday that gold has "broken above short-term resistance last week." Also, the firm is telling clients that the amount of gold held by GLD has increased in the past few weeks to November's high of about 1,300 metric tons, which, when combined with the technical price breakout, might foretell growing investor interest.
With GLD at about $110, the implied volatility of GLD's options is at 16.4%, which Strugger says is the lowest level since mid-2008. The low volatility reflects the recent do-nothing price movement, and offers investors a cost-effective way to speculate on an advance.
When Strugger modeled the trade, GLD's May $113 options cost $1.58, and implied volatility was 16.8%. The trade breaks even if GLD advances to $114.59.
It never feels completely comfortable keying a trade to technical analysis. In fact, the mere mention of technical analysis causes many traders to remember that all ships at the bottom of the sea are filled with charts.
But with GLD's implied volatility at such a low level, buying calls to bet on a short-term advance has a certain logic all its own for investors who are comfortable with speculations and peregrinations into some of the market's more arcane side streets.
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