Q&A

Explore Your Options

with Tom Gentile

Got a question about options? Tom Gentile is the chief options strategist at Optionetics (www.optionetics.com), an education and publishing firm dedicated to teaching investors how to minimize their risk while maximizing profits using options. To submit a question, post it on the Stocks & Commodities website Message-Boards. Answers will be posted there, and selected questions will appear in future issues of S&C.

GOLD: RUSTY METAL OR BUYING OPPORTUNITY?
Gold sure has gotten a lot of press so far in 2013. The metal started out the year on a high note — the first week of January saw gold at its highest levels for the year so far. Since then, gold has been on the decline, and in April it dropped off a cliff, taking a 10% plunge in just two days. As the bitcoin seems to be the “new thing” in decentralized currencies, gold had lost its short-term luster to investors. This digital phenomenon is the reason why gold may only be on a temporary drop, potentially to bounce back as everyone’s favorite by year’s end.

Is the bitcoin the “Internet bubble” of the currency markets? The bitcoin is a creation that has been around for only a few years now. Supposedly, a man using the name Nakamoto laid the foundation for digital currency. Bitcoins are paid when someone cracks a series of computer-coded mathematical problems. Once one of the algorithms is cracked, the miner receives bitcoins. As more and more bitcoins are mined, the algo gets harder and harder to crack until eventually there are no more bitcoins to mine. A bitcoin is a decentralized currency, meaning that no government can control it. There is also anonymity in how a bitcoin is spent. It’s traded directly from point to point, with no bank or reserve keeping track of how it’s swapped. Nakamoto limited the number of bitcoins to be produced, which is pegged to 22 billion. Roughly half of the allotted bitcoins have been “mined” from various computers thus far.

Gold may be on a temporary drop, only to bounce back as everyone’s favorite by year’s end.Mt.Gox became the first exchange to trade bitcoins as a currency. Some companies even use bitcoin as a form of currency with which to buy and sell. A report recently came out that someone accepted bitcoins for the purchase of a Porsche automobile. Some investors believe the bitcoin is the best hedge against inflation, deflation, and outright depression. The only problem is that the US government isn’t going to allow this currency to circulate without some form of regulation. Some bitcoin counterparts have been frozen or shut down for illegal money-laundering tactics, as the Feds call it.

The good news is that gold could get a boost from all this and once again shine in all its glory. How can you capitalize on the rebound, but at the same time hedge yourself if the dip isn’t over? Options! There are several ways to take a bullish position in the gold market using options. Here are three:

Options on gold futures: Gold futures are the most leveraged way to obtain a long (or short) position in the yellow metal. One contract on gold (GC) is equal to 100 oz., and therefore each point that gold rises is equal to $100 per contract move. Options on gold are one-to-one, meaning that one call option is equal to one futures contract. Of the three approaches listed here, this one is the most expensive, so it makes sense to use spreads on these longer-term contracts to cut the cost and risk.
Options on GLD: The gold ETF GLD tracks very closely with the yellow metal, but trades at roughly 1/10th the price. GLD does trade options, and as with equity options, one contract controls 100 shares of GLD. The cost of the ETF option will be much less than the cost of the option on the futures contract. Less cost means less out-of-pocket risk, but the reward would also be less if gold were to move higher. Options on GLD are one way to take a position in gold without having to spread your risks by selling options further out-of-the-money.
Options on a gold stock, such as Gold Corp (GG): Gold stocks have plummeted this year, much more so than the commodity, so if we were to see a real pop in the price of gold, perhaps the companies mining it would move higher as a result. This is also a less costly option, and profits will depend on the price movement of the stock.

These three examples demonstrate the different costs, risks, and rewards that should be considered when evaluating gold futures, gold ETFs, and gold stocks for bullish opportunities. If gold does return to its old highs by year-end, or even attempts it, a change in the underlying will be reflected in a change in the options on the underlying. Happy mining!

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