Gold prices and gold miners have been punished since all the way back in September. The Market Vectors Gold Miners ETF (NYSEARCA:GDX) is down about 20% since then.
And now, the Federal Reserve is expected to raise rates. The stock markets are also expected to shrug a quarter-point hike and finish the year strong. Markets have priced in great expectations for 2017. So a run for gold is not apparently imminent.
Today, I want to trade gold miner stocks via the exchange-traded Direxion Shares Exchange Traded Fund Trust (NYSEARCA:DUST). Although it’s a bearish index, I can still trade it in either direction. I aim to sell risk to generate income.
Click to Enlarge From a technical perspective, current levels in GDX are important for support. But I also have to account for the possibility of another 10% leg lower.
I am not calling for this drop, but I have to be mindful of the possibility. Should this scenario unfold, DUST would then inversely spike. Conversely, GDX is trading at the low end of this year range, so DUST could also have just as much upside.
Gold miner stocks usually track the SPDR Gold Trust (ETF) (NYSEARCA:GLD). Although GLD has already fallen from recent highs, it’s not clear that it hit bottom. Technically, I can argue for 5% move (in either direction) in gold prices in the next few weeks.
Thus, I believe selling risk against a range is better than choosing a direction. So I will balance my setup knowing we’re likely to have an active FOMC in 2017.
Because DUST is a leveraged ETF, it has enticing premiums, but they come with elevated risk. Caution is warranted, and tight stop-losses should be in order.
The Bet: Sell DUST Jan $34/$33 credit put spreads. This is a bullish DUST trade, so it’s bearish on gold miners. I collect 25 cents per contract to open. If successful, I would generate over 20% yield on money risked. Ideally, I need DUST to stay above my sold risk through expiration.
Instead of selling call risk against DUST and to balance the trade, I will sell bullish risk in GDX. (Remember: DUST and GDX are inversely related, so the opposite of bullish DUST is bullish GDX.)
The Hedge: Sell GDX Jan $18/$17 credit put spreads. This is a bullish gold miner trade for which I collect 11 cents per contract to open. If successful, this trade yields 12% with an 85% theoretical chance of success. I need GDX to stay above my sold risk through expiration.
Taking both trades means that I am neutral gold miner stocks through expiration within a fairly wide range so both trades expire worthless for maximum gains.
I am not required to hold either trades through expiration. I can close either trade at any time for partial gains or losses.
Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him on Twitter at @racernic and StockTwits at @racernic.
