by Tyler Craig | September 10, 2013 2:17 pm
With the recent rebound in stocks lengthening its stride, non-equity assets are losing some of their followers. The ongoing resurrection in gold is experiencing a mild bout of profit-taking. So far the selling spell in the yellow metal has been contained and may prove to be a low-risk entry point for traders who believe that gold has additional upside in store.
Nailing down the relationship between stocks and gold this year has been a bit tricky. These fickle frenemies sometimes move in lockstep, yet other times move in completely opposite directions. Currently the 20-day correlation coefficient between the S&P 500 and SPDR Gold Shares (GLD) sits deep into negative territory, revealing their recent tendency to profit from each other’s misfortune. What’s good for stocks has been bad for gold and vice versa.
Assuming this relationship holds, a bullish trade on gold probably has a better chance of success if stocks turn down again and remain in correction mode as opposed to surging to new heights yet again. Of course, entering a trade based on correlation alone is unwise — so let’s dig deeper into the chart of GLD to see whether its current posture merits a play.
With its two-week pullback, GLD has descended to the ascending trendline that currently defines its budding uptrend. If the dip-buying campaign continues, this is a logical area for support to form. The rising 50- and 20-day moving averages add further strength to the gold recovery and increase the chances for yet another higher-pivot low to form somewhere in this area.
Traders looking for GLD to remain above its 50-day moving average could sell the Oct 125-120 bull put spread for around 68 cents credit. The reward is limited to the initial credit received and will be pocketed provided GLD sits above $125 at expiration. The risk is limited to the distance between strikes minus the net credit, or $4.32, and will be lost if GLD falls beneath $120 by expiration.
To minimize the potential loss, consider exiting if GLD drops below the short strike price of $125. In timing the entry, you could wait for GLD to show signs of rebounding off the trendline — like breaking a prior day’s high or at least intraday resistance.
At the time of this writing Tyler Craig had no positions on any of the aforementioned securities.
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