Shares of the Gold ETF (NYSEARCA:GLD) have broken out big time to the upside. GLD raced past resistance at $129 and is now trading at the highest level since September 2013. Gold has been up for six straight days and has added on nearly 9% so far this month. The rally, however, is starting to look a little extreme. Time for some of the glitter to come off the recent red-hot move higher in GLD.
Certainly some of the move higher is warranted given the more dovish Federal Reserve stance on interest rates. A weaker U.S. dollar makes commodities, such as oil and gold, more expensive in dollar terms. This provides a natural inverse correlation between gold prices and the U.S. dollar.
Given that the dollar index is nearing major support at $96, I would expect a bounce, especially given the severity of the recent sell-off. This would provide a short-term headwind for GLD. The tensions with Iran also made GLD a safe haven play. Any easing of tensions would be a detriment for gold prices.
GLD is certainly getting extremely overbought on a technical basis. Its nine-day RSI is at the highest level in the past three years with a reading over 90. Its MACD has reached a nearly similar extreme. Momentum has also gotten to multi-year highs. The Gold ETF is trading at by far the largest premium to the 50-day moving average in that same time frame. Prices have gone parabolic, which is almost always a sign that the euphoric rally is poised for a pullack.
Implied volatility is also a high, trading at the 100th percentile. This means option prices are comparatively very expensive. Option selling strategies are therefore favored when constructing trades. So to position for the rally in gold to lose some luster over the coming weeks, an out-of-the money bear call spread makes intuitive sense.
I much prefer a safer, defined risk option play versus an outright short of GLD in this type of market environment.
How to Trade the GLD ETF
Buy GLD Aug $143 calls and sell GLD Aug $140 calls for a 55 cents net credit.
Maximum gain on the trade is $55 per spread with maximum risk of $245 per spread. Return on risk is 22.45%. The short $140 strike price provides a 4% upside cushion to the current price of GLD.
As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities. Anyone interested in finding out more about option-based strategies or for a free trial of the Delta Desk Research Report can email Tim at email@example.com.