Gold stocks are suffering their largest selloff since late last year. Just look at the damage inflicted across the broad swath of gold mining exchange-traded funds. The Market Vectors Gold Miners ETF (NYSEARCA:GDX) has fallen 17% off from its February high. Its higher beta cousin and the fund that will be in focus for today’s trade idea, the Market Vectors Junior Gold Miners ETF (NYSEARCA:GDXJ), has tumbled some 24% over the same time frame.
But why stop there? Let’s throw out the performance of a couple of the high-octane leveraged funds for the degenerate gamblers among us.
The Direxion Daily Jr. Gold Miners Bull 3X ETF (NYSEARCA:JNUG) and Direxion Daily Gold Miners Bull 3X ETF (NYSEARCA:NUGT) are down 59% and 44%, respectively. In summary, sellers are ravaging the gold patch with extreme prejudice.
While the budding investor may view the bearish onslaught with horror, options traders know opportunity lurks amid the fear fest. Allow me to enlighten you on why GDXJ is our gold stock fund of choice for today’s proposal.
On the liquidity front, all four ETFs mentioned above pass muster. Their options boast tight bid-ask spreads along with sufficient open interest.
The reason GDXJ is the most attractive for our play is two-fold. First, at $33, it’s much easier to structure an options trade around than the twin leveraged funds, JNUG and NUGT, which sit in the single digits. And second, GDXJ has a higher implied volatility rank than GDX (47% vs. 18%), which means its premiums are the most pumped up.
Before we dive into the strategy idea, let’s size up the price chart of GDXJ. Considering the severity of its ongoing slide, the fund has officially reached oversold status. Look no further than the Stochastics indicator shown in the lower panel of the accompanying chart, which has submerged well beneath the 20 level. While the fund could certainly fall further, the odds are starting to favor a rebound here. And yet, because GDXJ has broken through multiple support levels, it’s next bounce will likely be that of the dead-cat variety.
So here we sit. I want to be a seller of GDXJ at higher prices since it’s now in a downtrend. And I wouldn’t mind being a buyer at lower prices since further stretching to the downside would further increase the odds of the fund finally snapping back from its oversold status.
Strangle GDXJ for Profit
Throw all the analysis together and the short strangle trade looks like an appropriate fit. It is a short premium strategy designed to profit from rangebound behavior. Sell the April $38 call while simultaneously selling the April $29 put for a net credit of $1.40 or better. The reward is limited to the initial $1.40 credit and will be captured if GDXJ sits between $38 and $29 at expiration.
To increase your odds of success, consider exiting the trade when you can buy back the strangle for 70 cents. You will capture 50% of the max profit.
Since the strategy involves selling naked options, the max risk is theoretically unlimited. I suggest exiting the position if the fund rises above resistance in the $42.50 area, or if it falls below support near $28.
As of this writing, Tyler Craig held short strangles in GDXJ.