Depicted: Gold covered call writer . Insured for first 30 foot drop of his stock portfolio.
Why Did Gold Rally?
by Vince Lanci and Fay Dress for the Soren k. Group
(On the road)
Originally posted here:
http://ift.tt/2qWSdaM
Gold spot is up $12 today after barreling through $1260. Last is $1268 as of this writing.
Aside from the usual culprits, a weak USD and global political uncertainty, today was an example of what happens when expirations and mechanical ‘rollovers’ are triggered. Mechanics and cash flows are basically event related and automatically done.
But every so often, when large open interest is near, you get a digital reaction to a tiny move. In this case, the options market at expiration can and was a contributor to the rally today. That is not to say the rally is not “real”.
In fact quite the opposite. it means that the market is respecting risk more efficiently to the upside now too. Bluntly put: Shorts had to cover in a panic.
Revenge of the Gold Calls:
The catalyst for higher prices today was in part due to surprised people and automated systems with no ability to be discreet. What does that mean?
It means that a market like gold that gets hammered in sell-offs as longs puke simultaneously; now also has the ability to trample people higher. The panic coin now has 2 sides! And as option guys we so love it when the shorts actually have to cover at expiration. The strikes that may have been the drivers were, $1250, $1255 and $1260 on Comex.
To understand why a short option player covers in futures we must first quickly assess what types of players sell calls and why they sell them.
1- Producers who have metal and do not need to buy futures if the call expires in the money.
2- Speculators who do not want to buy futures and so usually cover the options when they go in the money.
3- Covered Call Writers who are long Gold or GLD and were selling programatically to create a dividend.
It is the last category that we feel is the culprit here. Equity investors typically are induced by brokers to sell calls to create dividends for their investments. It is this same behaviour that drives people who are long GLD to sell calls now. And it is done almost automatically.
Sell Call> Call expires worthless> Sell next month’s call. Lather rinse repeat. They do this in GLD options. Brokers love it because of commissions. But the retail ( and sometimes institutional) client does not get the active management he should to do this.
Why does this Affect Comex Options?
The guy who buys the GLD Call from the seller is a professional trader. He then sells the Comex’s corresponding Call to offset his risk and complete an arbitrage.
We know this because 2 of our writers did/do it. There is a whole list of risks for the arbitrageur to manage tied to different expiration dates and times.
The important thing here is to understand that it is the long GLD investor who likes his “guaranteed” monthly dividend who drives option-based short covering rallies now. And that folks, is a good thing.
We are not just talking retail here. No, this is a strategy universally done by hedge funds as well.
-Long a stock
-Buy a Put for downside insurance
-Sell a Call to offset the Put’s cost.
This is commonly called “collaring risk”. Selling a Call and buying a Put on a long stock position is called the “collar”
Hedging For Dummies:
The problem when you do that in GLD or in Gold directly is that when Gold goes through your Call, you generally do not want to be short it.
You are long gold as a hedge for the rest of your equity portfolio. So what in heaven’s name would make you want to cut your upside potential in it? Who hedge’s their hedge? Do you want to give up your insurance (long Gold) at the time when you need it most?
Would you buy fire insurance for a $1mm home only to sell the rights for coverage above $100k damage?
If Gold IS the Put for your equities positions, selling calls against it is uninsuring yourself.
Calls are Undervalued Because of Robotic Behaviour:
Modern portfolio management has opted passive over active management. And they are in some places automatically applying their option strategies to their “safe haven” hedges like gold. It is going to end badly at some point.
Because Gold is for the modern portfolio manager the PUT, or insurance for the rest of their portfolio crashing. Call selling is idiotic in this case. And as traders of volatility, we would say the skew that undervalues calls and overvalues puts in Gold is something to lean into long term.
One Possible Scenario Last Night:
Short covering buy stops that were hit in the $1260 area.
We think a decent contributor is option expiration related to the short covering, as the market closed yesterday with the $1250 calls expiring in the money. Complacent option shorts were woken up to a need to buy ASAP.
Comex- had expected to lose 200,000 contracts of options open interest. But it lost 349,921!
This implies option shorts were covering, and ITM expiration were panicking someone
Open interest in futures 478317,continues to rise with bargain hunters,worriers all asset allocating as price makes news on dollar moves
Political worries,G-7 talks, Greece,N.Korea, Venezuela,Brazil all playing a part.
Rate hike expectations have been priced in
GDP up 1.2,inflationary winds durable good down .07 vs expected down 1.8
So economy in the US ahead of budget talks another step up.
Expect continued upwards pressure after next week perhaps pause when FED meets.
Roll over proceeding June-August gold over 50%done,
More August trading now 340 value,gold-silver 73.05 improved,gold-plat 303.10.
H/T George Gero
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Good Luck
via http://ift.tt/2qrkpiO Vince Lanci