Walking through the Trade (GLD, EPI, TBT, AAPL, GDXJ)

Let’s run down a few trades before we dig into the main course.

And we’ll start with this –

A long, long time ago, way back in October of 2013, we bet on the long bond falling. We bought the TBT January 80 CALL for $11.00 and sold the January 110 CALL for $4.75 and everything expired out of the money.

Loss of $6.25 on the trade.

bad

On September 8th we got India in the blood and bought the January 24 EPI CALL for $0.90 while selling the January 21 EPI PUT for $0.30. And we didn’t give it enough time. India is now breaking higher, but we took a loss. We’re out sixty bucks and looking for an auspicious moment to reinstate the trade.

On November 10th we express doubt on Gold’s rebound. We sell five GLD December 122 CALLs for $0.48 each, for a total credit of $2.40, and buy one GLD January 106 PUT for $1.43. Total credit on the trade is $0.97 and that’s what we get. All options expire OTM.

Profit of $97 per round traded.

Finally, on the 24th of November we pair Apple (NASDAQ:AAPL) against the junior gold sector, for no other reason than the one looks overbought and the other oversold. We buy the AAPL January 100 PUT for $0.38 and sell the GDXJ December 24 PUT for $0.40, giving us a $0.02 credit for every pair written.

And that’s the way it ends. We come home with coffee money and call it a day.

A New Day – A New Lesson

 

If we never lost, we’d never learn. And it’s our intention at present to take our lumps and turn ‘em into winners.

Below, we sketch out how we develop a trade from the technicals through to the selection of an appropriate trade vehicle.

Have a look.

occupied

We have to say that the moves in the precious metals are VERY interesting at the moment and it’s VERY exciting to think that the three and a half year bear market in gold and gold mining shares is over – particularly when you see 2% and 3% moves like we have in the last few days.

The interest in gold was likely spurred by the Bank of Switzerland’s latest moves with its currency, releasing it from its long time peg against the Euro and thereby letting it rise substantially, while sending its own stock market into the desolate nether regions.

bib

Right.

In any event, the PMs and miners popped and it’s now our job to digest the move and predict whether or not something genuine is afoot here, or whether we’re looking at a knee-jerk action – a counter trend rally in an ongoing bear that’s about run its course.

And for that, we have to turn to the charts.

And what do we find there?

gld11915

Here is the SPDR Gold Trust (NYSE:GLD) for the last six months, and it clearly shows –

1) An enthusiastic, parabolic climb off November’s bear market bottom (in red), and…

2) Last Friday’s touch of the long term moving average (in blue).

We also see that neither RSI nor MACD are showing great signs of worry.

So…

What emerges from this is the distinct feeling that we may be at the beginning of a new bull market. Or, we may not. Nothing is as yet conclusive. So long as the metal is trending below its long term moving average (in yellow), and the MAs are all unwound and by and large trending lower, we have little to get excited about. We admit the possibility that we’ve seen a bottom here, but we’re not running to the bank with it.

On the other hand, GLD has come to a logical stopping point for the latest up-move. With the touching of the long term, yellow MA it’s very likely we’ll see some selling pressure here – and perhaps a lot. And it’s for that reason that we’re going to consider the following trade.

First, we are going to buy some PUTs on GLD because they’re cheaper now than they’ve been in a long time (after all the recent buying excitement), and because we think a fall here is likely over the near term – call it for the next three months.

At the same time, we have to give the bulls their due – albeit in a backhanded manner. How? We’re going to hedge our trade with the sale of a bearish CALL spread, which we’ll explain forthwith.

bearspread

A bearish CALL spread is a credit spread. It allows us to pocket premium, and in this case, use those funds against the purchase of our long PUTs.

We’re going to set the spread just above the long term moving average (in yellow) as that line appears a reasonable point of overhead resistance.

We’ll sell the April 123 CALL for $4.40, buy the April 127 CALL for $3.05, and earn for ourselves a $1.35 credit to offset the price of our PUT.

In a perfect scenario, GLD will close out-of-the-money, below the 123 strike, and we’ll pocket our original premium of $1.35 (less the cost of the PUTs).

But the credit spread comes with risks, too. The difference between the strikes of the two CALLs represents our maximum loss. Because we’re using the 123 and 127 strikes, we stand to lose $400 (127 – 123) should GLD close above 127 come April options expiry.

The PUTs we’re going to purchase are the April 116s, now trading for $2.17, making our total cost for the trade $0.82 (217 – 135).

Overall Risk

 

If absolutely everything goes wrong with the trade and GLD streaks heavenward, cheeks’a’slapping, we’ll be out $400 on the spread and another $82 on the cost to initiate. That’s $482 in the red.

The best-case scenario is GLD diving off a cliff and smacking its head on the reef, a development that would win us a theoretically ‘unlimited’ fortune (less our $82 to initiate).

[mepr-rule id=”994″ ifallowed=”hide”][mepr-unauthorized-message][/mepr-rule]

[mepr-rule id=”203″ ifallowed=”show” description=”wall_street_elite_members_only”]

Wall Street Elite recommends you sell the GLD CALL spread indicate above, and buy one GLD April 116 PUT against it for a total debit of $0.82 per trio traded.

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[mepr-rule id=”988″ ifallowed=”show” description=”executive_lounge_members_only”]
Wall Street Elite recommends you sell the GLD CALL spread indicate above, and buy one GLD April 116 PUT against it for a total debit of $0.82 per trio traded.

[/mepr-rule]

With kind regards,

Hugh L. O’Haynew, Senior Analyst, Normandy Research

See what people are saying...

  1. Jesper Markenstam

    I’m not very good at sizing spreads. Perhaps, I should 10x them when it’s a long / short option spread that pays towards a directional play such as this. So I made very little on this – like 30 bucks. We live and learn.

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