Gold lost another $7,70 an ounce today and the 5 day RSI level is getting more oversold by the day. If we look at a long term chart, it is evident that a bottom is near although we could get some more selling from here but only very slightly. Probably one more day of heavy selling or if gold could drop to $1,200 would set up gold for a bounce from this level as then the 5 day RSI indicator would be on a par with historical levels (or even lower)
The mining stocks frighteningly enough are not as over sold as gold so it looks like more selling pressure is on the horizon. However this is the beauty of options. With (NYSE:GDXJ) plunging to under $33, one could easily say that gold will not print its daily cycle low until the junior mining ETF reaches $30. However with options we can take advantage of high implied volatility, duration and taking profits early which all increase our probability of success. For example, let’s say we sell the July 8th $31-$29 put spread in (NYSE:GDXJ) for $0.66 per contract. The chart below shows that our probability of profit on this trade is 64% but that is if we hold the contract until expiration. If we buy back out put spread(s) when they reach $0.3 for example, our probability of profit goes way up – probably over 75%. Furthermore selling this put spread brings back your break even to $30.33 (higher strike – premium received)
Source : Dough.com
So why did I pick the vehicle (NYSE:GDXJ) for this exercise? One word – volatility. If we look at a volatility chart over the past 12 months, we can see that the ETF’s volatility is still above average which makes it an ideal candidate for selling option premium. Selling premium in a good strategy in the gold market at present as long as the underlying in question has above average volatility. Furthermore by selling the put spread 42 days out, you are giving yourself time to be right. Even if the daily cycle low takes place at even lower prices, the duration of your option spread becomes your ally as every day your sold option will be undergoing theta decay. Theta decay is powerful especially if you have multiple options positions on at one time.
Why? Well its a form of leverage in the sense that every time you sell an option, that option by design will lose value every day. Furthermore even if the put spread ends up a loser near expiration, astute traders roll their positions out in time to give themselves even more time to be right. As long as your initial opinion on direction doesn’t change (Gold is only dropping down into an intermediate low which should only last another 6 weeks in my opinion), even if your options spreads are temporarily underwater, roll them out in time 7 days before expiration and let the bull make them profitable once more..