Trading the Golden Coil with Straddles

by Tyler Craig | April 27, 2012 11:03 am

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Gold has been a chop-fest of late where only the nimblest of directional traders have come out unscathed. Recent price action has been nothing more than a jumbled mishmash of mean reversion.

While short-term traders may have had difficulty divining direction, long-term traders haven’t fared much better. Over the past few quarters, gold has found itself in the midst of a symmetrical triangle that has acted as a noose, constricting prices into an ever-narrowing range.

GLD Implied Volatility (IV)
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Not surprisingly, implied volatility has consistently drifted lower throughout the triangle formation. Such movement makes sense when one considers the realized volatility of the SPDR Gold Trust (NYSE:GLD[1]) has been on a downward trajectory as well. With GLD moving less and less, traders are simply unwilling to pay elevated prices for GLD options.

With the apex of the symmetrical triangle looming and implied volatility having now fallen near multi-year lows, long straddles are beginning to look somewhat appealing. To review, long straddles consist of purchasing an at-the-money call and an at-the-money put in the same expiration series.

The strategy comes equipped to exploit a large move outside of the triangle in either direction as well as a rise in implied volatility — two events that look to be increasingly likely with the passage of each day.

The truly tricky part of this play lies in the timing. Bottom-picking implied volatility as well as forecasting when the triangle breakout will commence can be quite difficult. Since the strategy involves buying two at-the-money options, time decay will be a constant annoyance, eating away at the value of your position. If the breakout fails to materialize or implied volatility fails to lift quickly enough, the straddle will be a loser

Currently, the June 161 straddle is trading for $8.30 while the July 161 straddle is trading for $9.95. Both look to be in play for those banking on a coming resolution to the GLD triangle. Though a bit more expensive, the July position will be less affected by time decay.

An alternate consideration would be to wait for the breakout and then buy calls (upside breakout) or puts (downside breakout).  Assuming implied volatility is still depressed at the time, option buying is the way to go.

At the time of this writing, Tyler Craig had no positions on GLD.



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