The Spread Trader: Straddle On SPDR Gold Shares (GLD)
Gold has been on an incredible, historic run. At the end of 2008, the yellow metal was trading at roughly $700 per ounce. For the next four years, it would do nothing but head higher.
In fact, in August 2011, gold hit a high of over $1,900 per ounce. And even though the price pulled back somewhat in 2012, it’s held up over $1,500 or more for most of that period. That’s still very high compared to historical prices.
Basically, gold has served as an investor safe-haven during tumultuous periods. Investors have used gold as a hedge against currency depreciation, banking woes, political uncertainty, inflation, deflation, and more.
However, the precious metal party may just be over.
For the past couple days, gold has fallen steeply. As of this writing, the price of gold is down more than $100 per ounce, or over 8% just today. This after the yellow metal took a hefty 5% dive on Friday.
All in all, gold is currently trading under $1,400 per ounce for the first time in two years.
Here’s the thing…
Investors are finally realizing the global economy is not going to drop off the edge of a cliff. There’s no hyperinflation right around the corner. Major governments aren’t on the verge of collapse. And, central banks plan on doing whatever necessary to keep banks in business.
Does that mean there’s no longer a reason to own gold and other precious metals?
Well, I don’t think it’s that cut and dry. A lot of important investors still own gold. And don’t forget, gold has been used as a store of value for thousands of years. I don’t expect it to become worthless anytime soon.
As such, this looks like a great opportunity for a straddle spread on SPDR Gold Shares (GLD). This direction-neutral strategy is made by buying one call option and one put option at the same strike price.
The point of a straddle is to capture gains on a big move in gold, regardless of direction. In this way, investors don’t have to guess what direction gold may be headed. Whether gold keeps plummeting – or whether it rebounds – it doesn’t matter to the straddle buyer. As long as it does one or the other, the trade’s a winner.
Here’s an example…
Buy the GLD May at-the-money straddle (133 strike) for around $10.50. That’s roughly $5.25 for the call and $5.25 for the put, with the stock trading right around $133.
By May expiration, this trade becomes profitable if GLD is trading below $122.50 or above $143.50. Given how much gold is likely to move after today, this seems like a very plausible scenario.
Now for the best part… unlimited profits!
Since the straddle is a pure long position, there’s basically no limit to how much this trade can earn.
Of course, the straddle is best used in a situation where a lot of movement is expected in the underlying. Reserve this type of trade only for the most volatile situations, as it can be expensive to put on. However, with gold in a major state of flux, this is a perfect time to trade the straddle.
Yours in Profit,
Gordon Lewis
Category: The Spread Trader
