After lying dormant for the past month, gold looks poised to continue its rise. The recent consolidation has allowed the yellow metal to digest its January gains and work off some overbought readings. These periodic consolidation phases also allow the stock to build a strong base from which to launch when the next upward thrust begins.
Click to Enlarge While a number of bullish plays might be appropriate at this time, those looking to traverse the higher-probability route might consider selling out-of-the-money put spreads. In selecting the optimal time frame, the March monthly options seem a bit too close while the April monthly options seem a bit too far. Fortunately, the SPDR Gold Trust (NYSE:GLD) offers March quarterly options, which provide an acceptable compromise.
To review, bull put spreads consist of selling to open a higher strike put while buying to open a lower strike put in the same expiration month. The net credit received at trade inception represents the maximum reward available and will be captured if the stock resides above the higher strike put at expiration. The maximum risk is limited to the distance between strikes minus the net credit, and will be incurred if the stock resides below the lower strike price at expiration.
Currently, the March quarterly 165-160 put spread can be sold for around 90 cents. Consider it a bet that GLD won’t fall beneath $165 by the end of March. With the potential reward capped at $90, the maximum risk comes out to $410. This represents a potential return on investment of 22%, which is pretty common for a vertical spread structured in this manner.
The potential risk can be mitigated by exiting early, such as if GLD falls beneath the short strike price of $165.
As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.