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Making Green With Gold

Stocks in this article: GLD

For millennia, people have valued gold. There is something unique about it that no other metal has. Even today, it is still used as an asset that is the foundation of our modern system of fiat currencies.

We are certainly in an era of big government spending and deficits. All of the major central banks have engaged in some degree of quantitative easing, flooding the world economy with newly created money. This has lead many to wonder if we have a future of runaway inflation, despite the near deflation conditions currently extant. Gold is the natural hedge against this scenario, and many investors include it as a permanent part of their portfolio.

Gold is unique among asset classes, in that its correlation with other classes is uniformly low. By my calculation, the correlation between gold and stocks has been only 15% over the last five months, based on daily net changes. Typically, the correlation between individual stocks and an index, is north of 80%. So, gold offers diversification benefits few other assets can match.

We are also entering a seasonally good time of year for gold. For all these reasons, I think a bullish play on gold makes sense here. The SPDR Gold Trust (GLD) is now the second largest ETF in the world and offers a pure play on bullion. My choice is a butterfly spread:

Trades: Buy to open 1 GLD October 119 call for $3.45, sell to open 2 GLD October 123 calls at $1.86 and buy to open 1 GLD October 127 call for $0.91.

The net spread is $0.64.

The risk on this trade is the $0.64 debit. This is a bullish spread with a delta of .08. So, it is roughly equal to the risk of 8 shares of the fund. We will set our stop profit at $123.00 and exit with the maximum profit if the fund reaches that level. Otherwise, we exit the trade at the October expiration.

At the time of publication, Phil McDonnell held no positions in the stocks or issues mentioned.

Phil is a professional options trader and contributes regular commentary to the Daily Speculations website. Prior to trading professionally, McDonnell was a software developer for Dollar/Soft, a financial software company specializing in options software for equities, indices and futures. He also wrote the book, Optimal Portfolio Modeling, which was published by Wiley Trading in February 2008.

OptionsProfits, a new provider of options news from TheStreet, educates investors and acts as a catalyst for trading.

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