by Tyler Craig | February 12, 2013 8:37 am
Amid an otherwise lackluster day in stocks, gold fell to a one-month low Monday, breaking a trendline support level which has been in place since mid-December. The breakdown brings resolution to the symmetrical triangle pattern that has driven gold prices into an increasingly narrow range over the past few months.
Click to Enlarge Some gold bulls might fear Monday’s 1% drop in the precious metal could be signaling the beginning of another impulse move lower that brings new depths to gold’s current downturn. Compared to the S&P 500’s 6.6% rise so far in 2013, gold’s 1.4% decline is far from impressive.
But, hey, if you own the SPDR Gold Shares (NYSE:GLD) and are looking for a silver lining, just be glad you’re not in gold mining stocks. Since ringing in the new year, the Market Vectors Gold Miners (NYSE:GDX) has fallen more than 10%.
Click to Enlarge One way to add color to analysis in the gold space is to view a ratio chart of gold miners (GDX) vs. the actual price of gold (GLD). When the ratio rises, gold miners are outperforming; when the ratio falls, gold miners are underperforming.
As shown in the accompanying price chart, the ratio has been dropping steadily since October, showing the stark relative weakness in GDX.
With the broad rally in stocks, it appears investors can find plenty of better places to park their money than gold miners. A longer-term view of GDX reveals a multiyear support level lurking a couple bucks beneath the surface at $39. If the current downtrend continues, a test of this level is all but inevitable in the coming months.
Let’s explore a put spread that could double your money if GDX undergoes just such a move.
Put spreads offer a cheaper, less risky alternative to buying put options outright when you want to bet a stock is going to fall in value. To give ourselves plenty of time for GDX to drop a sufficient amount, we’re going to use June options.
Let’s buy the June 42.50 put while selling the June 40 put for $1.55 or better. The max risk is limited to the initial $1.55 paid and will be incurred if GDX sits above $42.50 at June expiration. The max reward is limited to the distance between strikes minus the net debit, or $1.95. To capture the max reward GDX needs to fall beneath $39 by June expiration.
As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.
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