The only reason any investor or trader is in the stock market is to make money. Historically, gold has always been a great investment, as people love gold and it stood the test of time. Recently however, over the past couple of years, it seemed that gold had fallen out of favor, and the popular gold indices fell and stayed below their 50 day moving averages. Times seem to be changing, and it may be time to reconsider gold as an investment.
JUSTIFICATION FOR THE EXPECTATION OF A GOLD RUSH
Some might argue that ‘Gold Rush’ is too strong a label for what I am about to suggest, since there is no way of knowing the future and what might be. However, something to consider is, like the great US Gold Rush, those who get in early will likely make the most profit. Prudent investors and traders might ask the logical question ‘What proof is there that I should consider gold as an investment now?’ To them, I answer – one has to learn to read the signs of the times in the stock graphs to know that it would be wise to consider gold as an investment or trading opportunity now. Let me explain.
Most prudent investors and traders may broadly be divided into those who base their decisions on fundamental analysis or technical analysis (I am discounting the naïve wannabe investor who follows every hot tip). While fundamentalist attempt to evaluate the underlying worth of the investment (which may or may not agree with similar analyses done by others), the technical trader chooses to wait until popular sentiment is noted on the stock chart before they start investing. This generally means that the technical trader will enter the market later than the fundamental investor. However, this does not matter for the individual trader since most major investments nowadays are done by institutions and hedge-fund managers, and they usually enter into their positions slowly over many weeks. The best strategy for an individual investor and trader is to spot a trend relatively early, and hop on for the ride as soon as he/she is able.
GLD gaps above the 200 day moving average
GDX gaps up at the open confirming the break above the 200 day moving average
HUI establishes a new high for the year, breaking above the 200 day moving average
Above are three graphs of the popular gold ETFs with overlay of the 50 and 200 day simple moving averages. One will note that all the indices hit a recent bottom at the end of December 2013, and have since been trending up. Most investors and traders who follow trends, especially mutual fund and hedge fund managers, wait for the stock (or underlying) to rise above the 200 day moving average before they begin investing (see The True Importance of the 200-day Moving Average). Once they begin investing in a particular underlying stock or ETF, they usually do so slowly over a period of weeks attempting to buy the underlying at the lowest possible price. Hence, I use the term ‘Gold Rush’ as I expect once this trend starts, it will likely continue for a long time. The next logical question for the investor or trader is ‘How can this knowledge help me?’
BULLISH OPTIONS STRATEGIES TO PROFIT FROM A GOLD RUSH
Assuming that the technical signal given by the 200 day MA holds, how should an investor or trader capitalize on it? The answer depends on many factors including the investor/trader’s time horizon (short-term vs. long-term), available capital (money ready to be deployed), and investing and knowledge and expertise. The following is a non-exclusive list of some of the choices – not surprisingly, options traders have more options than the ‘pure stock investor’:
- Buy the ETF – This usually is only a viable option for major institutions and hedge-funds as it involves a lot of capital. It is also the simplest to understand – buy low, sell high.
Choice 1 – Buy the GDX ETF
- Protective put (married put) – Like the above, this requires a great amount of capital, but it has the advantage that it limits the down-side risk (see Protective Put).
Choice 2 – Buy GDX Protective Put
- Buy a call – For the options trader, this is the simplest bullish strategy to follow. Usually, the best option to buy is one that is slightly out-of-the-money (OTM) as it gives you ‘more bang for the buck’. For more details on why and how the delta of these options matter, see Options Trading Strategies.
Buying a call substantially decreases the amount of capital required, and often traders may buy lots of 10 or more to take advantage of the leverage offered and the lure of unlimited upside profit.
Choice 3 – Buy GDX Call
- Buy a call spread – This is a great strategy for the options trader, but does require a little more understanding of the relative effects of price movement on the long and short options, and a decision of which options to buy (‘how far out in time to go’). For more detail, see Options Trading Strategies. Like buying the call, as the amount of capital at risk is low; unlike the call, upside profit is limited. The advantage of the spread over the call is that the ETF only has to rise a little for the trader to make a great ROI (return on investment), and often buy many lots of 10 rather than single spreads.
Choice 4 – Buy GDX Call spread
As noted in the examples above, the profit attainable and risk assumed differ with the strategy chosen, and each investor/trader needs to decide what works for them. Although the future is not predictable, smart investors and traders learn to consider the reward-risk ratio in their decisions; the current graphs suggest that for an investment in gold now, the rewards outweigh the risks. Although the examples are using GDX (screenshots courtesy OptionsXpress), the strategies listed above can be done with any of the other ETFs. For more on how to place orders, see How to Trade Stock Options Online. Options traders have many, many more choices to consider depending on their level of understanding of sophisticated strategies – including the collar, rolling collar, rolling protective put, backspread, and combining strategies such as a protective put with a backspread. The advantage of more sophisticated strategies is the ability to combine unlimited profit with limited risk. That’s a topic for another day …
Happy Trading!
