Gold’s at Its Cheapest (Volatility) Price EVER

by Tyler Craig | November 26, 2012 8:37 am

The realized volatility in Wall Street’s favorite gold proxy — SPDR Gold Shares (NYSE:GLD[1]) — has remained within its normal range of late, but implied volatility — as measured by the Gold VIX (CBOE:GVZ[2]) — has stealthily fallen to all-time lows.

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As shown in the accompanying chart, the GVZ has dropped to the low 13 level — an area otherwise unseen since the CBOE launched the gold-based VIX Index in mid-2008.

Before we delve into the implications of this record-low volatility, though, let’s briefly review the nuts and bolts of implied volatility.

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In the world of options pricing, implied volatility is king. Its importance is paramount, as its behavior can have substantial ramifications for the profitability of a position. An option’s price — like any tradable security — is driven by supply and demand. Implied volatility is a handy metric that provides traders the ability to gauge the supply/demand status of an option.

The following two phrases reveal the interplay between supply, demand and implied volatility:

  1. When demand overwhelms supply, implied vol will rise.
  2. When supply overwhelms demand, implied vol will fall.

You might notice the term “price” could be interchanged with “implied vol” in the prior two statements. Rather than being a mere coincidence, this speaks to the direct relationship between an option’s price and implied volatility. Namely, when all variables are held constant (stock price, time to expiry, etc.), a rise in an option’s price will result in a rise in implied volatility.

The fact that GVZ has fallen to all-time lows means that options on GLD are the cheapest they’ve been (in volatility terms) in years. So why not exploit the fire sale and snatch up GLD options at bargain prices?

Traders looking for bullish exposure could buy the March 168 calls for $6 or better. The risk is limited to the initial $6 paid at trade entry while the reward is unlimited (as GLD can continue moving higher).

Shareholders of GLD also could exploit the relative cheapness of its options by employing the stock replacement strategy (sell your shares and replace with a long call option) or buying protective puts.

As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.

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  1. GLD:
  2. GVZ:
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