Oct 21

I am not a fan of gold. For those who are, are you putting your money where your mouth is? Do you think gold will be over $1250 by the end of 2010? That’s ‘only’ 21% higher than it is today. I’ll pass along a secret, odds are 4 to 1 against it happening. If you feel otherwise, that it’s a sure thing, I’ll share with you how to collect that payoff. First a disclaimer: The following involves the use of exchange traded options. I’ve not discussed these instruments before, and will be providing only a brief overview to explain a specific strategy. Don’t do it unless you understand it. Even if you do, don’t do it.

goldoptions

This is a clip of the option quotes for the GLD ETF which trades at 1/10 the price of gold. An option gives you the right but not the obligation to buy the underlying stock at the strike price you choose. For example, $1450 gives you the right to buy 100 shares (options are priced per share but trade 100 at a time) of GLD until Jan 21, 2011 for $100/share. If gold rose to $1200, your $1450 would rise to $2000. Make sense?

Now for the 4 to 1 bet: if you bought 1 option at the strike price of $115 for $950, and sold the $125 option for $710, you would be out of pocket $240. If gold closed at $1250 on Jan 21, 2011, the $115 option would be worth $1000, and the $125 option is worthless, and you’ve gotten 4 times your money. Note, if it closes any higher, the difference between the two strikes is still $1000 no matter how high it closes. Below $1150, and you’ve lost your bet. In between and you’ll get something back, $100 for every $10 dollars gold is over $1150. As I said, I don’t recommend this, it’s just a thought experiment for me. Given the choice between actually buying gold or taking a fraction of that money and placing this bet, I’ll take the bet. You can lose it all, but gold can also crash to less than half its current value. Any questions on this gamble (I don’t call this investing) please comment.

Joe

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