GDX: A Golden Volatility Opportunity

Exploit the high volatility in GDX with short strangles

The pain in gold mining stocks worsened this week as virtually everything related to the yellow metal took another plunge into the abyss. Plagued by the continued advance in the U.S. dollar, gold miners fell to their lowest levels since the horror show of 2008. The Market Vectors Gold Miners ETF (GDX) has now fallen an astounding 75% from its peak.

Market Vectors Gold Miners ETF GDX
Click to Enlarge
Source: MachTrader

Indeed, the halcyon days of gold’s once epic bull market couldn’t seem farther away than they do now.

While I suspect at least a short-term bounce is in the cards for the beleaguered GDX, what I find more interesting is the current status of implied volatility in the gold space.

For the uninitiated, implied volatility measures the buying and selling of option contracts. When demand for options rises, the implied volatility is driven higher reflecting the now elevated levels of option premiums. Alternatively, when demand for options falls, implied volatility drops reflecting the now depressed levels of option premiums. As an option trader, the ideal times to sell options is when implied volatility is elevated.

And that, as it turns out, is what we see currently in the GDX.

Click to Enlarge
Source: MachTrader

The easiest way to chart implied volatility for GDX is to use the CBOE Gold Miners ETF Volatility Index (VXGDX). As shown to the right, volatility has risen to the upper end of its three year range driving option premiums to some of their richest levels in months.

With GDX in the midst of a steep downtrend, I suspect the occasional rallies will get sold into. On the flip side, with GDX so utterly oversold, further downside might be limited.

In sum, the gold ETF may be somewhat rangebound for the coming month.

How to Trade GDX

To exploit the potentially expensive option premiums as well as rangebound price action in GDX, consider shorting a December strangle by selling the Dec $15.50 put and simultaneously selling the Dec $19.50 call for a net credit of 78 cents.

The max reward is limited to the initial 78-cent credit and will be captured provided GDX remains between $15.50 and $19.50. The max risk is theoretically unlimited, but keep in mind your expiration breakeven points are actually $20.28 and $14.72, so GDX can trade in a rather wide range while still allowing you to profit.

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

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