Use Options to Play QE3

by Lawrence Meyers | October 3, 2012 9:15 am

So the Fed has initiated yet another round of quantitative easing. I’m not here to judge whether this plan will help at all (even though it won’t). Instead, I’m here to tell you how to use options to profit from yet another government-driven market event.

The big goober about QE3 that’s going to stick in everyone’s craw, particularly those on fixed income, is that it will cause inflation. We’re already seeing it, although the government’s CPI report doesn’t give you the true insight. That means the more income you can generate now, the better off you’ll be as the value of that income erodes.

Bank of America analysts have come out and said gold will hit $3,300. I think that’s kind of high, but I do think that gold will continue to push higher over the medium term. That’s perfect, because it allows you to play gold directly in many different ways, and roll options over month after month for regular income.

I like to use the SPDR Gold Shares (NYSE:GLD[1]) for this. Gold’s volatility means potential for nice premiums. If you believe (as I do) that gold has a price floor, you could buy the underlying and repeatedly sell covered calls a month out. As of this writing, GLD is at $172.10. You can sell the October 172 calls for $2.25. On the flip side, you could sell naked October 172 puts for $2.12. You get almost the same return and don’t have to put up any capital to buy the underlying. You could also just buy a long-term in-the-money call. The January 2014 135 calls are going for $41, allowing you to buy GLD for 25% of the underlying’s price, and only giving up $4 of upside.

If gold goes up, the dollar is very likely to go down. Unfortunately, there aren’t great ways to play the dollar using ETFs. PowerShares DB US Dollar Index Bearish (NYSE:UDN[2]) would be the way to go here, but the premiums really aren’t worth it.

Oil, on the other hand, offers plenty of ways to get involved. Bank of America sees oil going to $190 a barrel, a number I also think is too high. Still, I’m looking for as much as a 50% increase in the price of oil down the road. I think that “forever hold” energy plays like ExxonMobil (NYSE:XOM[3]) and Chevron (NYSE:CVX[4]) are great choices to buy and repeatedly sell calls against. You can also play oil directly with the U.S. Oil Fund (NYSE:USO[5]). The November 34 calls are going for $1.44, a juicy 4.2% premium if you want to buy the underlying. Alternatively, you can sell the 34 puts for almost the same premium, and thus collect the premium without investing a cent. If you like oil over the long term, the January 2014 36 calls are going for almost $4, so that’s a 12% return over 15 months.

There are many other plays in the oil and energy arena, including selling calls against the Energy Select Sector SPDR (NYSE:XLE[6]). The stock is at $73.93; you could sell the September 2013 75 calls for $6.05. That’s setting you up for a 10% return with significant downside protection. It also affords you some diversity, as you are moving one step away from the price of oil.

At the time of writing, Lawrence Meyers owns shares in GLD.

Endnotes:
  1. GLD: http://studio-5.financialcontent.com/investplace/quote?Symbol=GLD
  2. UDN: http://studio-5.financialcontent.com/investplace/quote?Symbol=UDN
  3. XOM: http://studio-5.financialcontent.com/investplace/quote?Symbol=XOM
  4. CVX: http://studio-5.financialcontent.com/investplace/quote?Symbol=CVX
  5. USO: http://studio-5.financialcontent.com/investplace/quote?Symbol=USO
  6. XLE: http://studio-5.financialcontent.com/investplace/quote?Symbol=XLE

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