Jan 21

From the department of “time flies” – back in October of 2009 I wrote a post titled “Will Gold Break $1250 by 2011?” At the time, gold was trading for $1034, and many people were saying they expected it to go still higher. Now, I wasn’t a believer, I made that clear, but for those who were, I offered a way to make 4X on their money (a 300% return) over the next 15 month through an options spread.

Allow me to recap the strategy. First, gold is traded as an ETF priced at 1/10 the price of one ounce of gold. The above snapshot is from October 2009 when I wrote the first article. Now, a brief explanation of options. 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 GLD rose to $120, your $1450 would rise to $2000. Make sense? At $120 you would make the profit from the $100 strike to the $120 current price, a $20 gain or $2000 for the contract. For this play, however, I suggested buying the $115 strike for $9.50, and selling the $125 strike for $7.10. This way, you are out of pocket $2.40 but can gain watch that $2.40 rise to as much as $10 as GLD goes to $125 (or gold to $1250). Keep in mind, even at $120, this bet would have doubled your money. The downside is that if gold didn’t rise to at least $1150, the entire investment would be lost.

Really, it would have be sweet if I were a gold bug and claimed to put my money where my mouth was, putting up, say $25,000 and claiming it’s now $100,000. No such luck. But in the end, if anyone were so bullish on gold that they followed this strategy, they would have seen a 27% move in gold produce a 300% return on their money. Not bad. I believe gold is in bubble territory and there are similar trades that when the bubble bursts, there’s some good money to be made.

Joe

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May 08

I’ve followed the derivatives issue for some time, and have a very tough time feeling that the derivatives themselves were to blame for anything. Puts and calls on traded stocks and commodities are priced by supply and demand, but the Black–Scholes model offers a convenient equation to calculate a ‘fair’ price. On the other hand, when the rating of a product is severely flawed, any derivatives based on that product will be flawed as well.

Joe

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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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