While most experts agree the long-term outlook for gold prices is still bullish, the yellow metal's pattern this summer can only be described as one of fits and starts.
In all, gold has made 11 short-term bottoms since May 29, the lowest being a close at $1,552.40 an ounce on June 28. Meanwhile, subsequent rally attempts have all quickly run into resistance, stalling out at near $1,620.
This start-and-stop action makes it extremely difficult for investors to avoid being "whipsawed."
Fortunately, there's a way around this dilemma: Just use an options trading strategy that lets the market itself tell you exactly when to buy gold.
And, here's the best part: This clever options trading strategy will cost you only a few dollars.
It can be used on gold futures – e.g., the standard 100-ounce CME Group contract, on any of the gold mining stocks or on the much more affordable gold-backed exchange-traded funds (ETFs) on which options trade.
Taking the Guesswork Out of Gold Prices
For ease of explanation, I'll base our example on the most popular and actively traded of the gold ETFs – the SPDR Gold Trust (NYSEArca: GLD).
Recently quoted at $155.75, the price of a single GLD share usually tracks the price of one-tenth of an ounce of gold (discounted by 2.5%-3.0% for fund expenses and storage costs for the metal that backs the shares).
Here's how you would initiate the strategy, based on actual prices available last Friday:
- BUY an out-of-the-money call option with a strike price $4.00 to $5.00 above the current price of the underlying GLD shares and an expiration date four to eight weeks out. Using GLD's July 27 price of $157.25, that would mean buying a September $162 call, priced at about $2.48 a share, or $248 for the full 100-share contract.
- SELL an out-of-the-money put option with the same expiration date and a strike price $4.00 or $5.00 below the current GLD share price - ideally one just above the lowest price in the most recent series of up-and-down swings. In this instance, that would mean selling the September $152 put, priced at about $2.21 cents, or $221 for the full contract.
The cost of the combined position is thus just 27 cents ($2.48 - $2.21 = $0.27), or $27 total.
For simplicity's sake, I'm using single options in the example. In practice, you'll buy and sell one option pair for each 100 shares of GLD you want to purchase, and the cost will rise proportionately.
You will also have to post a margin deposit to cover the sale of the short put. In this case, that would be about $2,620 - but you'll get it all back in eight weeks unless the put is exercised and you get to buy GLD at $152.00 a share.
And what do you get for your $27?
In brief, you get a position that takes the guesswork out of when to buy gold – or, more precisely, shares in the GLD gold ETF – and also cushions you against limited short-term volatility.
How This Options Trading Strategy Works
Between now and the Sept. 21 option expiration, GLD share prices can fluctuate as much as they want between $152 a share and $162 a share, and it won't affect you one way or the other.