Options

Gold bug? Here are two clever ways to play it.

By Lee Lowell  |  September 20, 2018

I’ve never been a gold bug, but I know a ton of people who are.

Honestly, I’ve never understood the fascination with the shiny, yellow metal.

Other than the few pieces of gold jewelry and coins that I own, I’m not so sure what it can do for me on a larger scale.

(Although my favorite Twilight Zone episode is about gold and, unsurprisingly, has a genius plot twist at the end. It’s absolutely worth 25 minutes of your time!)

Sure, for centuries, gold has been a reliable currency and, more recently, the go-to asset in times of turmoil. But does it really have value?

Just like artwork, stamps, vintage guitars, or even baseball cards, if enough people put a high enough price on something, the object or material in question is accepted as a valuable asset.

But you typically don’t pay with gold bullion (or baseball cards) when checking out at the grocery store, nor does the precious metal have much industrial use in, for example, housing construction or electronic gadgets.

Whether by sheer chance or more complicated historical circumstances, certain items have more value than others, and gold is one of the biggest.

A Little Gold History

During my tenure as a pit trader on the New York Mercantile Exchange (NYMEX), the building also housed the Commodities Exchange (COMEX), which was where precious metals were traded. These contracts included gold, silver, platinum, and palladium.

I’d known a number of the metals traders, and all of them loved gold, to the point where not one of them was ever bearish.

If you weren’t long on gold, you weren’t relevant.

But during the 90s, which made up the bulk of my time on the exchange, gold could never get its mojo in gear, languishing between $300 and $400 per ounce.

To me, there was no money to be made on a dud like that.

It wasn’t until mid-2005, near the peak of the real-estate bubble, that gold began its ascent above $400. And although it took a slight tumble when the financial crisis hit in 2008, it regained its footing and rambled on to hit all-time highs near $2,000 per ounce in 2011.

Since then, gold has worked its way back down, unable to muster any more bullish activity. It currently sits near $1,200 per ounce.

Here’s a long-term chart of gold futures:

Your Best Bet To Get Long Gold

Although I have no stake or interest in buying gold, I’ll admit, based on the chart formations, gold could be forming enough of a base to make the case for a move higher.

I recently went over some proprietary information from the very popular Ned Davis Research Group, and I saw that one of its current models is showing extreme pessimism in the gold market – a contrarian indicator that typically has shown positive movement in the price of gold soon after.

If I ever take a stake in the commodities markets, I use futures and futures options contracts as my investment vehicles. Currently, the front-month futures contract for gold is the December 2018 contract.

But since many of our readers are active in the stock markets, you can play gold with relative ease by using the SPDR Gold Shares ETF (NYSE: GLD). Here’s the current chart.

GLD will trade in sync with the actual gold spot and futures markets, which makes it easy to get in and out of at will. It also has options contracts, which is music to my ears.

With GLD currently trading at $113.50 per share, there are a couple of good ways to play it. Take note, though, that these aren’t official recommendations, merely examples of the sort of plays you can make on gold. I won’t write any follow-ups, so look deeper into them if your risk profile warrants it.

1. Buying a deep-in-the-money (DITM) call option

I’ve given many examples (here and here) of my DITM strategy, and it could be a perfect way to play an immediate bullish bet on gold.

If you were to buy 100 shares of GLD at today’s prices, it would cost roughly $11,350.

But a June 2019 $90 GLD call option will cost roughly $2,540, a cash outlay 77.6% less than buying the stocks outright. The key to picking this specific call option is its 90% Delta, which gives the option almost point-for-point movement with the stock.

If GLD were to move back up to its near-term high of $128 per share by next June, the stock purchase would yield a ROI of 12.8%.

But the ROI of the call option would yield 49.6%, almost four times as much. Plus, the call option is saving the investor $8,810 versus the GLD shares purchase.

2. Selling an out-of-the-money (OTM) put option

I’m sure by now you know how strongly I feel about selling put options. Put options are the backbone of my Instant Income Alert service, and I’ve written about them more than anything else in The Rich Investor (you can see my whole archive right here).

If you feel gold might still have a bit more downside, you can “name your price” at a lower level that fits your risk profile.

For instance, a June 2019 $100 GLD put option is currently paying out $43 per each contract sold.

This will place an immediate $43 in your pocket in exchange for buying 100 shares of GLD at $100 per share. You would only need to follow through with the agreement if GLD trades below $100 by June 2019. If not, another put option can be sold at that time to repeat the process.

At GLD’s current price of $113.50 per share, the put option gives the investor another $13.50 per share of downside cushion, which equates to roughly 12% below GLD’s current value.

There you have it! Two great ways to stake a bullish claim in gold if you’re so inclined.

Lee Lowell

A former Wall Street insider and floor trader, Lee Lowell has worked in the market for nearly 30 years now. He began his option trading career in 1991on the floor of the New York Mercantile Exchange (NYMEX) in New York City.MORE FROM AUTHOR