On a quiet Sunday evening this week, when markets are at their least liquid, someone sold more than 24,000 ($4 billion in notional value) of Gold futures contracts, pushing the price down by almost $100 at one point.
There were no obvious catalysts for this slump and no fundamental news to explain it, which means it could present an opportunity to trade the metal, as the collapse ended very close to previous lows around $1684.
There is likely to be some price variability in the short term, so options may be the best way to play this move.
Strangle Option
I am looking at buying what is called a strangle, whereby one buys both a call and a put option either side of the current price for the same expiry date to take advantage of a strong move (in either direction).
If the lows around $1670 are broken, there could be a shakeout down to around $1350, whereas if the market regains its footing, a corrective decline could be over, allowing a test of the $2000 levels- as it is not yet clear which move is more likely buying both calls AND puts allows the investor to profit either way.
At a gold spot price of $1721, $1735 Calls for December (confusingly, they actually expire on 23/11/21), are priced at $49.2 whilst the $1710 put is at $50.7;
I have chosen the November 23rd expiry to avoid any possible time decay, should prices remain unchanged for a week or so, which would erode the option’s value.
Buying both these options would leave the investor slightly long the market (about 2 deltas, or 2% of the weighting of a futures contract), which would fall progressively the lower the spot price of gold falls.
Trade Potential
What of the upside potential? The total cost of the two options is (49.2+ 50.7) is 99.90, so the breakeven on expiry would therefore be below $1610.80 and above $1834.2, but this assumes it takes 3 months to be achieved; we would hope to see prices move much more speedily than that.
If we assume a move to recent high or low points ($1460 in March 2020, or highs of January 2021 ($1960) in the next 2 months and we further assume no change in implied volatility, the strangle (both options prices combined) would be worth $251 (at 1460) or $225.8 (at $1960).
The quicker the targets are reached, the better the profit would be, as there would be less time value erosion on the options.
There cannot realistically be a specific stop loss as the holder of a strangle is long both ways directionally speaking, so a time stop loss would be employed.
Should prices not move for a period of, say 6 weeks, one can assume that the impetus for this trade has gone and thus both options should be liquidated, resulting in a potential loss of around $20 or so, giving a risk/reward ratio of around 5x.