Gold futures have been mostly out of favor since peaking in March on the heels of the war in Ukraine.
But now we are seeing signs of life. Buyers are stepping in on dips. My column from last week regarding the U.S. dollar suggests the currency market could be due for a change in tone. If so, that would finally give the green light for speculators and hedgers to get back into gold. After all, inflation and uncertainty are high, while risk assets are volatile, in theory, this is the perfect recipe for inflows into precious metals.
As of the latest Commitments of Traders, or "COT" report, large speculators were holding the smallest net long positions seen since the 2018 bottom. This suggests there are plenty of sidelined buyers that could be lured back into the market if the trend turns higher. Remember the, weekly COT report reveals the aggregate holdings of various U.S. futures market investors.
Precious metals are volatile and room for error is a must. We like the idea of using options spreads with a January expiration. Specifically, using a bull call-spread with a naked put to pay for it. This strategy comes with unlimited downside risk, so it should only be used if you have tolerance for risk and quite a bit of available margin. Better yet, this is probably used as a paper trade for educational purposes.
Options, option pricing, and volatility are complex and unpredictable. So, options trading risk shouldn't be taken lightly. If the price of gold goes south, which would be against the position, it will be necessary to hedge price risk with short futures -- micro- or mini-ones, depending on the situation. Even paper traders will need to be on their toes.
The Trade: A January Bull Call Spread With a 'Naked Leg'
- Buy the January Gold $1,800 Call
- Sell January Gold $1,900 Call
- Sell January Gold $1,650 Put
Total Cost: About $4.50 s or $450 plus transaction costs.
Risk: Unlimited below $1,650
Maximum Profit: About $9,500 if held to expiration, which isn't likely. A worthy goal would be $2,500 to $4,000
These options expire on Dec., 27 120 days to expiration
Alternative Idea: Go Really Small
A more conservative approach to investing in precious metals would be to either buy a micro gold future (10 ounces and $10 per dollar in price change) or even the Small Exchange precious metals futures. Each of these contracts enjoy the benefits of futures (tax advantage, efficiency, and leverage) but come with a smaller margin requirement, lower risk, and higher comfort levels. As a bonus, the E-micro gold futures are available for trading for 23-hours per day.
The Core Idea
We have many ways to gain exposure to gold, but the futures markets are generally the most efficient. This is because traders can buy and sell contracts around the clock without the hassle of shipping, storing, or exchanging the bullion. Yet not everyone is mentally equipped to trade futures outright (particularly the full-sized gold contract of 100 ounces); prices move fast and fearlessly. Option spreads can potentially offer traders a smoother ride in a tough market, but as we have pointed out, options trading comes with substantial risk and requires some practice in a simulated account before going live.
Remember, there is a substantial risk in trading options and futures and doing so may not be suitable for everyone.