Feeling Lucky? Gold Speculation Using Options For Leverage
Originally published July 4, 2016
A subscriber wrote to ask for some thoughts on using options to speculate on Gold moving up over the next couple of years.
As you know, I am personally against using options for leveraged speculation.
However, each investor knows their own portfolio needs, objects, risk tolerance, and situation best for themselves.
I am sharing my reply with all of my subscribers because I know we all are curious about this form of gambling.
Feeling lucky? Luck is a lot more common in the movies than in real life.
A subscriber recently wrote asking my thoughts on how to use options for a leveraged speculation in gold over the next 1 to 2 years. I am sharing my reply at part of transparency and because I know many give this a thought from time to time. Speculation such as this is certainly not part of our covered option writing program.
As you probably know, Personally, I am against using options for speculative leverage. However, since you asked, I will share some thoughts on how it can be done (remember, I'm not an expert since I don't use options this way).
Options have 2 parts to them, a price component, and a time component. This is a very important difference. If you buy and hold the underlying security, when it goes up does not matter, you can always opt to hold it longer. An option has a time fuse that begins running down the moment you buy one. Thus, with an option, you must get the direction of the price move correct, the size of the move, and the timing of the move right. If the security goes up, but not as high as you set for you base (breakeven point) and you run out of time, then you end up with zero. Your entire investment is gone. So, first thing you will want to consider is what is going to drive gold up, when will it happen, when should it be done with its run (remember, if it peaks in 6 months and you have a 2 year leap, it may run all the way back down and further by expiration. Or you can early exercise your option and sell the gold, losing the remaining time value of the option and then perhaps see gold doing its major run up start a week later). So, you want a model of when and why gold is going to move and how quickly. You want the reasons for the model and what might change the timing or size of the moves. Only then can you make a plan and contingency plans to consider trying such a speculation. Otherwise, I can assure you that the professionals and the random surges and plunges will eat you up alive.
With those cautions and caveats out of the way, here are some ways to use options to leverage a long horizon gold move to the upside:
Buy call options that expire near the end of the run up and allow for several weeks or months beyond your model so you have some flexibility. A call will leverage 100 shares of each contract, costing you only the option premium to control the full asset value of those 100 shares. Remember, the longer the contract, the more "time value you will pay" and thus the more expensive the total premium will be. Select the price at the current money to lock in all the net upside gain that might occur between now and exploration. Again, here that is going to cost you the maximum premium in the "intrinsic" part of the option price because the nearest the money is the most expensive pricing.
For even greater potential leverage, put short term call contracts that expire early in the time gold should be starting its move under your model. This will allow you to cash in on those early and then re-invest your early profits in even more options so that you effectively are doubling down (or a fraction thereof). You can ladder your contract dates out over time so you do this repeatedly if you want to go for maximum speculation and risk. On the other side of risk, a ladder approach will allow you to take money off the table periodically if you desire. For that, you may want to consider laddering your contracts near your ultimate long term exit date for your gold model.
If your gold model has a basis for anticipating a price level (range) at give periods going forward, then you can try more sophisticated option structures such as spreads or straddles. You can use asymmetric structures such as condors also, which allow you to structure pairs of option contracts with a bias in one direction or the other within a certain range of prices or times or both. These can get very complex and you probably want professional help with them if you decide to consider them. I am not qualified to explore the most sophisticated of them with you even in a general discussion.
As to LEAP vs conventional, the difference is only in the duration. A LEAP generally is considered longer than 1 year.
I will not try to argue you out of your plan. Only you can determine if its appropriate for your overall portfolio and personal goals and risk tolerance. I will suggest you ask yourself this question: Why Gold? Why not pick a stock or ETF that you can understand the forces and timing that drive it better and use the same strategies for that. Perhaps you have some Gold expertise. If not, then do consider alternatives to get to the same goal by a different path that you know best. If you are going to speculate, its best to eliminate all the unknowns you can and focus on the path you are the most capable of understanding and being able to react to real time changes in.
Best of luck with it,