Is gold’s “safe haven” status wearing off?

Is gold’s “safe haven” status wearing off? 

 

The term “safe haven” is back in the investor lexicon. With stocks off to a brutal start to 2016, gold got some favorable attention for the first time in a while. Up over 50 dollars low to high since the year began, gold has certainly been a beneficiary of some of the chaos in the world. But does that make it a safe haven?

 

Perhaps, but don’t fall in love with the idea that gold is the thing you buy when stocks are down. The last week or so has shown that a down stock market does not necessarily mean higher gold. Today the February gold futures contract made a high of $1109.9. That is lower than the 1113.1 high that gold made on January 7th. Stocks made a new low today with the S and P making a low of 1804;  on January 7th the low in the S&P was around 1930. So 125 handles lower in the S&P later, gold did not make a higher high.

 

I am aware anyone with a chart can look at that and notice it, but I think it is important to point it out to make sure that we are all looking at the facts with respect to gold’s price action. It is true that gold has generally been up on days stocks have sold off, but at least for the greater part the last two weeks, one would be hard pressed to argue that gold performed well for investors during this period of struggle for stocks. Cash would’ve done just as well.

 

As some of you who have read my writing before know, I often like to focus on the identity that gold is being given at different points in time. This lack of continued inverse correlation between gold and stocks makes the safe haven label hard for the metal to maintain. Perhaps a lack of general demand means that it should get sold, but that isn’t obvious either. If stocks recover, it doesn’t necessarily have to go down, but a strong rally in stocks would likely put some short term pressure on gold.

 

If you really want to know what makes gold move take a look at the yen.

 

goldyen

 

90 Day hourly Gold and Yen

 

The purple line is the Yen, the green and red is gold. You can see that the general patterns of these two have been very close. The yen ran into some strong selling this morning when stocks were selling off, and perhaps that is what helped keep gold in check today. Whatever the case may be, the burden  of proof for gold bulls looms large. If gold is simply pausing in the midst of a longer term move upward, I would expect it to retest 1075-1080. Below there it starts to look ugly, above that it looks like gold is consolidating above the lows which will reinforce 1080 as the critical level of support. Keep in mind 1080 was the low of the overnight crash last July. Funny how the same numbers seem to pop up in gold all the time.

 

One thing I can say from speaking with traders I know is that no one has gotten it completely right the last few weeks. The price action has been choppy across asset classes. Sometimes, following all this volatility (at least in stocks) it is easy to get caught up in the hype and look for the next opportunity to score big. I personally am taking a neutral stance for the time being. I like to put trades on when there is a clear reason that makes sense to me. Right now, I see gold in the middle of a range from 1080-1110 lets call it. It is sitting right on a major number (1100). A very similar range was carved out 100 higher (1180-1220). Those who traded that dreaded market will remember gold’s love of chopping up all the speculators who bothered to participate. Even if gold is a huge buy or sale, I’d rather miss the first 20 dollars and put trades on when and where there is more reason to have some conviction.

 

 

I will write more as more clues become available to us. Gold has certainly run into some resistance here, so I wouldn’t be in a rush to get long. If you want to put a short trade on here, I think you can do so while keeping a reasonably tight stop. In order to make the risk reward worth it, I think you’d have to be looking for at least 1060 on the downside. But if the last few weeks have left you a bit out of breath, follow me and take a few days to and see what develops.

December Fed Looming, Gold Stands at an important inflection point

Two posts ago, on November 16th, Gold Returns to Critical lows below 1100, I wrote the following.

 

So now, gold has found some buying around 1073, but has shown a lot of difficulty picking up any steam to push it towards 1100. This is an incredibly significant battle that the longs and shorts will fight out in this range. 40 dollars higher gold looks like a commodity that is finding real support and an ability to hold up dramatically well amidst all of the worlds commodity selling. 25 lower makes gold look very unattractive.

 

A month later, this still holds true. Despite a temporary move down to 1045, we are more or less in a range. Broadly speaking, that range has been 1060-1080. I think the levels, at least on the upside are becoming a bit clearer, and we can begin to focus on critical price points in anticipation of this week’s Fed. 

 

You might expect I would show a short term chart to discuss these levels, but I believe they apply to much bigger levels. So, let’s look at my favorite chart in gold because it tells so much; the three year daily.

 

 

 

 

The slow moving downward channel gold has been in for years is crystal clear on this chart. 

What I will mention from here on out about this chart is not technical analysis; it is just gold analysis. Even if you have never looked at a chart before, you can see that gold has demonstrated certain clear price pattern characteristics when approaching the extremities within the range.

 

Notice the very first low in July of 2013. That was the establishment of the lower line of this channel. How long did it spend there? Not long. It quickly rallied up to the top of the channel. Then revisiting this new down channel in December 2014 it rallied relatively quickly to the top of the channel. You can see how this pattern continues throughout the years.

 

Why is this so important?

 

Look at where gold is now. It is hovering at the bottom of this lower line. The last time it hung out on the line was this summer after the overnight 50 dollar drop to 1080. It consolidated before rallying nearly 100 dollars. Could we be seeing something similar here? My major takeaway from this chart (which is why I always come back to it for reference) is the speed at which gold rallies off of the lows. It is one of the reasons one might understandably adopt a strong bullish stance. In the last few years, betting on rallies off of the lows of this line have proven to be very profitable.

 

I will come up with the next argument for the bulls in a few, but there is also a way to see the above chart in a critically bearish light. 

 

Forget lines on a chart for a second and think about what it means when consolidation occurs at a certain price level.

 

Consolidation takes place at levels where buyers or sellers at a given point in time don’t strongly outmatch the other. There is some buying and some selling, but not enough to push a market heavily in either direction. Over time however, when either the buyers or sellers throw up the white flag, the interest on one side of the market gets cleared out. This allows for a potentially accelerated move once the consolidation has commenced.

 

If you take a look back at the chart above, gold is consolidating along that lower trendline. Last time it did this it rallied 100 dollars in less than 2 months. So what is potentially bearish? The Speed at which gold sold back off  to here following that rally.

 

Below I am going to reinsert the same chart above.

 

Now focus on the lower trendlie. Notice that following December 2013, gold did not interact with this line again until a full year later. In July (only 7 months after gold revisited in November 2014) gold came back retesting the 1080 area. The latest consolidation that gold has been experiencing began in November, and has continued to consolidate for longer than at any previous time gold traded along the line.

 

 

There are two elements of this price action on the longer term chart that signal the potential for a strong down move. First, the time intervals that gold is interacting with the bottom of the downtrend are shortening. The return more quickly to this support line shows that rallies are fading more quickly across the time frame you see above. Thus while the market has clearly shown strong buying off of this level, the bull party seems to be ending more quickly.

 

If Wednesday’s Fed decision leads to a break of this line on the downside, I think it opens the door for at least 100 dollars in downside. I would consider a break of 1055 as a true break of this line. The longer a line has held as support, the more likely a break of that support is to lead to swift down move. In the case of gold, a break of support would be confirmation that years of efforts to rally have failed.

 

Finally, I’d like to focus the other line you see above. Below is gold for the last 10 months or so.

 

select blake lively dresses

 

This line you see slices down the middle of the down channel we have been looking at. Notice how the line served as resistance in May and June. You can see how precisely this line served to stand as resistance over the course of the last 8 months. The break above the line led to an accelerated move higher; and soon after, an accelerated down move back to the line. Now, as you can see, gold is consolidating below this line. The last time gold broke above the line in early October, it rallied 60 dollars rather quickly. While chartists might deny the validity of this line, I have more reasons for focusing on it. I have noticed that options demand begins to flip (calls get bid above it, puts get bid below) as gold’s price relative to the line changes. Markets are not science. There are clearly others in this market who use this line as a guide for future price, and that is enough to command our attention.

 

 

It is rare you get a chance to see so many of the price patterns and trends converge at critical points simultaneously. Right now, as I have tried to convey in this post, gold sits in the middle of some very significant cross currents. It is probably not a coincidence that these cross currents are meeting head on in front of the big December Fed announcement. As it stands there is a greater than 70% chance according to markets that the Fed will raise. So, gold finds itself at a major decision point as markets approach the event (potential rate rise) the markets have been waiting for for years. A break higher opens the potential for a yearly close in the 1180-1200 range where gold has spent so much of its time. A break lower opens up the door for new multi year lows. Even if there is not a big move on Wednesday, there will be potential for big moves in the coming days and weeks. Big events like this tend to exhaust either buyers or sellers. Even if the move is not immediate, the potential for 50+ dollar moves over a 1-2 day period will increase at such a point of buying and selling cross currents.

 

Wishing everyone good luck this week; I will try to write next weekend and discuss the events of the coming week.

 

Gold Quietly Breaks 1050

Gold Quietly Breaks 1050

By Ben Ryan

The dollar is what is ruling these markets right now. For the time being, the gold price seems inextricably linked to the dollar. Higher dollar, lower gold; and vice versa.

There have been some buyers coming in in gold this week, but the dollar spoiled their plans starting around 5 this morning. Bad European economic data caused the dollar to rally. The dollar rally extended at 8:15 when the ADP preliminary employment number came in better than expected. The dollar continued making new highs as Janet Yellen spoke in the afternoon. By the end of her speech (which my angry colleagues tell me I am lucky to have not listened to) the dollar had given up all of its gains, even dipping back below the psychologically important 100 level on the dollar index.

The one thing that has actually been clear in these markets is what data is bullish and bearish for the dollar index. Bad Euro economic data is perceived as bullish dollar. Bad Euro data increases the perceived likelihood of European QE, which would put pressure on the Euro. Positive news in the US (good jobs report) increases the perceived likelihood that the Fed will raise rates later this month. Since there is at least a literal connection between interest rates and the economy, positive US data makes it appear that the Fed is more likely to raise. This, in turn should be bullish dollar.

But what happened this afternoon? As my friend put it, “She made it seem like they were going to raise rates, and the dollar rallied. Then she started talking about what might happen after that, and I just got confused”. Apparently, whatever confusing words she used were enough to bring some selling into the dollar, and gold managed to hold a low of 1049.4.

I find it interesting to note that the stock market took a turn to the downside after her confusing speech. I apologize for having not listened to the speech I am referencing, but I have been confused enough by her in the past, and will take people at their word when they tell me she made things unclear. The stock market does not like this uncertainty. We have seen this before. “Raising rates” is not necessarily enough to derail the stock market. We know this because stocks have rallied as the perceived likelihood of a rate raise has increased in the past few weeks. But market uncertainty about the message being delivered by the Fed is a different thing all together.

At this point, most market participants are banking on a December rate hike as an inevitability. A rate hike is thus largely priced into markets. The question will be, how do they describe their future intentions. If for some reason they don’t raise rates, gold could see an epic short covering rally. But my contention at this point is that a rate hike does not imply lower gold prices. It will, ONCE AGAIN, be in the language that is used.

I am not much for giving out gratuitous advice, but I’ll make an exception this time. Try to go into the announcement flat if you can. That is my game plan. Over the past two years, I have seen what seemed so obvious NOT work on these announcements and major events. I have personally put on what I thought were well thought out positions into these kinds of events, only to lose a month of hard work in minutes. I know, I am not alone on that one.

One of the reasons the risk is so great right now is the general lack of liquidity that is so pervasive across markets. I will write more on this “fake liquidity” next time, but I have been watching the liquidity dry up in the gold futures and options markets for some time now. It has been getting progressively less and less liquid. Take today in gold for instance. ~4500 lots traded on what was clearly a stop getting run. The seller left 2000 lots (offered on the screen). After a few minutes of futures silence, buyers took the seller out. Then, with the exception of one small blip, there were no orders to be seen. One would think that a 6 year low might interest some participants. It didn’t. This is not the first low gold has made of late, nor is it the first time the participation following such a low has been a complete dud. To my mind, a multi year low would be reason for interest to pick up, but the volume is telling us otherwise. Rather than watching futures change hands throughout the day, you are seeing intermittent volume spikes, followed by silence. This is the ultimate sign of illiquidity, or at least, lack of participation. If a size player is caught of guard at an illiquid time, it increases the likelihood of a gap move. If you want to hold positions into the Fed announcement (or any time leading up to it) just keep in mind that getting out may be tough if it doesn’t go your way.

This Friday is the jobs report. As a colleague reminds me, trend changes in gold tend to begin on NFP days, and on Fed announcements. We will see how it plays out, and I will write more following Friday’s action.

 

Gold Returns to Critical lows below 1100

Gold Returns to Critical lows below 1100

By Ben Ryan

Gold managed to get a lot of people excited over the course of the last few months. Following the late July dip to 1080, it was unable to make any further progress to the downside. 1080 became major support, and the metal managed to rally over 100 dollars off of the lows to 1191. Then, in the course of about a week, all that hard work was undone, and gold is back near the lows of 1080, and mere ticks off of making a multi year low at 1073.

There are a few interesting things to note about what has gone on for gold, and how investors are approaching it. Interest rates, or more specifically, the expectation of a rise in interest rates has been the main driver of price. If you take a look back at gold’s price action in the last two months you will find that one basic rule holds: Expectations of a rate rise leads to gold selling, when the expectation is that a rate raise will be pushed further into the future, it gets bought.

The NFP on Nov 6, which came in better than expected, provided the impetus for sellers to knock the metal below 1100. The idea is, better jobs report means the economy is better, and therefore interest rates are more likely to go higher. The logic is not really logic at all. Sustainable jobs are not created from twenty five point raises or decreases in interest rates…. but the soundness of the logic behind interest rate moves, and gold’s reaction to them, is not our concern. We just need to know how gold is perceived at a given time, and what drives investor sentiment towards it. Lately, it has been all about interest rate expectations.

I found it very interesting to learn that the managed money crowd has been behind a lot of the selling. Take a look at the Nov 3 Commitment of Traders.

Screen Shot 2015-11-16 at 12.14.20 PM

Notice The -30,958. That would indicate the amount of futures that the longs in the managed money category got out of during the week. I read this as showing that managed money longs bailing marked gold’s last gasps in the 1180-1190 area. Had gold been able to recapture the 1180 area and consolidate the chart would look far different than it does right now. My view is that “managed money” is using gold as a proxy for Fed hike expectations, and the market is moving largely off of that view.

Wednesday, November 4th the Fed released their minutes from the previous meeting, and the general consensus was that the tone in the meeting was hawkish (expressing a greater likelihood that a rise in rates was imminent). The Friday jobs number helped to support that hawkish outlook…. Good jobs, less reason for the Fed to change their hawkish tone.

Where from here? Gold made a very interesting efforts at the lows at 1073. Unable to even make an effort above 1090, gold found itself retesting multi year lows.

gold15day

Note: Gold made highs near 1191 in the week previous to this chart, and likely marked the levels where managed money started selling. The selling was reinforced with the first big red candle you see at the top of this chart.You will notice that selling came in after 2pm on Wednesdayafternoon, just after the Fed had released their minutes.

Look at the volume on the bottom of the chart. You will notice that the the big down candles tend to correspond to high volume the whole way down, showing real selling. On Thursday however, there is major volume on a green candle at the low of 1073. Consider the longer term chart to see why this level is so significant.

08tonowgold

Look at gold from 2007 to now above. As I read it, someone looking to get short futures on these lows would likely be targeting ~1000 dollar gold, near where the old tops from 2007 should serve as support. But those shorts did not get their way on their first try last Thursday. As mentioned in the short term chart above, real volume came into buy at 1073, and defended the previous low. The shorts cleared out quickly as gold managed to rally back nearly 15 dollars, likely representing shorts giving up on their immediate plans to capture such a drop.

So now, gold has found some buying around 1073, but has shown a lot of difficulty picking up any steam to push it towards 1100. This is an incredibly significant battle that the longs and shorts will fight out in this range. 40 dollars higher gold looks like a commodity that is finding real support and an ability to hold up dramatically well amidst all of the worlds commodity selling. 25 lower makes gold look very unattractive.

Short term directional trades don’t make sense in this kind of range. If you want to play long or short, I think you need to be working with 25 dollar wide stops and looking for a big move in either direction. If the long/short battle in this range appears to be clearly going to one side, it may be worth it. For now, we will wait to see what this Wednesday’s Fed minutes reveal. We should be looking for any big volume that might come in and use it as important information in getting a sense for the bigger picture in the gold market.

In looking back at what I wrote I had to adjust the 100 handle on a lot of what I wrote. It is so easy to get confused as so many of the numbers 100 higher have such similar to the significance 100 lower (1180/1080 especially). Good luck trading and as always, please feel free to share any questions, comments or critiques.

New Range Established, Tread Carefully and Wait for Clues

There are three types of volatility: Implied, realized, and future. Realized is a measure of how much movement there has been during some time period in the past. Implied volatility is the price of options now, which is in some sense a forecast of what future volatility will be.

As a full time options trader, I spend a lot of my time dedicated to searching for patterns that give me hints of what future volatility will be. Looking at the charts and order flow among other things, I use the price of options and my expectation of potential moves to allow me to enter into a trade.

Take a look at the chart above. This is the 9 month daily chart of gold. In January gold made a high of 1307. It sold off rather quickly to 1142 (165 lower, or about 12%) in the course of about 50 calendar days. Take a look at where gold options are priced.

Gold implied volatility is currently trading around 16.5% for options expiring in 60 calendar days (November exp). If memory serves, volatility was priced similarly to where it currently is when gold was trading 1300. As I write, the 40 dollar lower put in gold expiring in 60 days (the November 1095 put) costs about 15 dollars. If it were to be compared to the equivalent put when we were trading 1300 in January, this would be approximately the 1260 put. That move (1300 down to 1140) took place in 50 calendar days.

 

Here is the trade in retrospect:

15 dollars of premium spent; if the put goes in the money and you cover at expiration, each put you bought will be worth the strike price minus where gold is trading. So, in our example case, where gold moved from ~1300 to ~1140 in 50-60 days, we buy the 1260 put for 15 dollars. On expiration, we are trading around 1142. (1260-1142=118). You spent 15 dollars for a trade worth 118, so you make (118-15) 103.

As a high schooler and college student I played poker as a means of affording some basics. I would rarely play games where I won or lost more than $1000, but it was my young version of trading. Poker taught me one incredibly important thing that I use in my job to bring me back to reality. If you know the implied risk reward of a situation, and understand some basic math, you can become a winning player. Whatever noise markets are blasting in our ears, we must ask ourselves if the risk reward makes sense. If we are not convinced that it does, or that a trade makes sense but comes with a caveat, it is not worth doing.

In our above example, you would have made a return of approximately 103 dollars on a bet that cost you 15 dollars. You could not lose more than the $15 you put up because you were the buyer. So, you made 103. To calculate the risk reward, we should ask what the number of outcomes like this we would need given this price for the option to break even.

Put more simply: we bet 15 dollars; we made 103. (103/ 15 = 6.8) So if you had an outcome this favorable one out of every 6.8x, this bet would be fairly priced. (6.8x you pay 15 dollars, so you spend 103 on making the bet, if you win once in those 6.8x you will have won what you paid to enter making it “fairly priced”)… there are more outcomes than this, but if it is a move hard or sit scenario, this kind of math is more applicable than would be in a whippier market like crude.

I will not say what makes gold options fairly priced; but as an options buyer you can wait until situations are favorable from a risk reward perspective given your understanding of historical pricing. You are in no rush to make bets. If you are, step back, that kind of mentality is what allows the options sellers to hold onto their profits despite selling vol many times in the last year below where vol was realized.

All of the charts I show are in an effort to show and determine what I see as patterns of buying and selling. If we can find lines, however random, that indicate to us the potential for consolidation, it makes the prospect of owning options all the more dangerous. If you paid similar prices for the option we just discussed from any time between late March and June you probably lost all of your premium. To make on that trade, your timing would’ve had to have been perfect.

Creating a fair price for gold options over a 4 month period can be very tricky. The market can sit still for months and then move quickly all at once. Most of the time it is actually overpriced, but the times it is underpriced, it is drastically underpriced. If you look at the chart, and assumed you could not time things, but rather made the same bet time and time again, you probably made a little bit over time. You would not  have made enough to justify seeking out trades like that. It is the most difficult discipline we need to keep when trading gold. Even if we are right that gold is going to collapse or rally 100s of dollars, owning options gets expensive if we are right a little bit too early.

The longer term (not seen here) chart seems to indicate that gold remains in a downtrend. I last wrote about how I expected gold to continue to trade higher if the S&P sold off. The relationship was short lived, once again bringing gold’s safe haven status into question. Funny enough, gold’s safe haven bid failed in the 1150-1170 range, which is where it failed when there was the brief and almost forgotten Greece default scare. While this has been a major short covering rally, the gold bulls must have been disappointed when gold stalled in the 1160s as the stock market continued its sell off. Below is the 9 day look at gold.

Notice how when gold topped out around 1165 the stock market had yet to put in its low (the purple line is the S&P) and gold progressively worked its way lower. While the bulls had a good run there was serious volume at the 1170 level (sellers defending against a move higher). For now, in the 1120-1135 range, gold sits right in the near the middle of its recent range (1070-1170) over the course of the last 2 months. It is why I think options buyers need to be patient here. As an options buyer you have the control. Being profitable requires the discipline to wait for situations where implied vols get relatively cheap, and you have a strong opinion that movement is imminent..

Why is gold volatility where it is right now? Overtime gold option implied volatility tends to get lower when it trades in the middle of a range. Why was 1 month volatility trading as high as 18% 2 days ago, when equivalent volatility was close to 12% before the drop to 1080? The chart definitely implied a greater chance for a significant move down and quickly at 1142 before 1080 than it does here. While the chances for going lower are still viable and in my slightly biased opinion probable, betting on having it happen quickly is challenging. If you are buying 1 month options and you are right just a month too early, you lose all of your premium. So what to do?

 

Nothing.

That in fact should be the answer most of the time. Nothing. There is nothing to do, but prepare for the next trade and wait for the opportunity that might arise. Gold’s volatility spike was almost certainly due to the volatility in the stock market. Even while gold stopped negatively correlating with the S&P gold volatility went out. In fact, gold volatility got bid as it moved BACK INTO an area (1110-1120) where it has consolidated before this last leg of the rally. One fairly trustable rule is that volatility will not get bid if the futures are reversing back into a range. That is exactly what happened.  Vol got bid as we came back into the range. When the Vix is trading in the 30s, it is not unreasonable that people who need to own options across markets (for whatever reason) might reach for some gold volatility. Gold volatility has been trading at historically cheap levels, and in a time of panic in stocks, it is not unreasonable for funds with short volatility exposure to buy some gold vol as a hedge. Gold at 16% as it currently, as opposed to the usual 12-13% we have grown used to when heading back toward the middle of a range, is not expensive relative to other asset classes’ volatility. So we are left with a strange situation in which we notice the inter-connectedness of all assets classes, and that gold’s implied volatility is relatively cheap compared to others. But should the stock market, and consequently other markets’ volatility settle down a bit (stock up, asset class implied volatility down) gold volatility should come in as well. If gold can move quickly in either direction from here, its volatility may justifiably hold up. But we can only operate on the information we have in front of us. As option buyers, we must realize that the price action of late does not show us a clear reason to believe realized volatility will increase. Implied volatility is also toward the middle-higher end of where it has been on a daily basis for the last year. Higher implied volatility combined with an unclear signal from the price action means we should stay away. With lower volatility and gold closer to either end of the range, options might become very attractive, I actually think that is likely. So while there are a lot of reasons to see the potential for gold to move hard in either direction, exercise patience. While I am sympathetic to the idea that options have been underpriced for a long time in the gold market, I also know how difficult it can be to manage a position when nobody cares to buy options. Death by 1000 paper cuts is still death. So be careful.

I want to reiterate that there are times when options can become very attractive, but that we need to be very diligent if we want to employ buying options as a strategy. Timing, which is a big part of successful option trading, is far harder to nail down than people who do not trade full time might think. Even if you are right over the long term, the smallest difference in timing can be the difference between a loser and a home run. I have seen too often the wrong reaction to this reality of markets. The answer is not that you need to level into positions time and time again. You don’t need to chase the market. You have to be willing to miss what look like incredible opportunities. This market has proven that options can get cheap before big moves. Here, is not the place to put on bets for just that reason. The medium term implied vol is too high right now relative to its mean, and the chart gives us no strong reason to feel strongly one way or the other about direction in the short term. Far too many of the profits I have made on the big moves have been eaten into by my haste to enter trades that are medium term smart, but short term stupid. I don’t want others to make the same mistake.

My hope in writing this article was less to discuss gold than to discuss some of the classic mistakes people make trading options. I make them all of the time, even when I am trading well. As traders we cannot control the speed of the market. As such we must always defend against our urge to put aggressive minded positions without strong cues that it makes sense to do so. Making money is no longer a daily expectation in this patient but prudent trading strategy. It would even be OK to suggest option trading to mom and pop if they understood one simple rule

 

Never Be Short Options.

If you are a long option/ long spread player you cannot lose more than the amount of money you put in. “Trading” which involves getting short options, is a totally different ball game. That is hard enough as a full time trader, and should not even be considered by a less active player. But for less active players, I would suggest studying some of the historical implied volatilities and weigh them against your expectations for imminent movement. If you can find yourself in a place where the implied volatility is low vs historical implied vol, and you have conviction of a move, then options can be a profitable way to play the game. But you have to be selective. Death by 1000 paper cuts is still death. If you choose to track the market closely, than you will be able to see situations where the risk/reward to play the game is very favorable. If you are not willing to pay close attention, you will slowly bleed buying options in this market.

Be patient, and make sure that if you have a strong directional opinion that the implied volatility is relatively low compared to where it has been. If you see that the implied volatility is extremely low relative to its historical mean, get involved ONLY if you have a real conviction that it might move.

Markets have been a bit finicky lately, and it is easy to get caught up in the hype and feel like you need to participate. This can be a big trap and a more costly one than immediately meets the eye. There are ways to make money in these markets, but the prudent ones will realize that staying flat the majority of the time is the smart move now. Opportunities will arise but we cannot control when they come. If we keep a close eye, we will find opportunities while others are throwing their hands in surrender having painfully paid for options right before things calmed down. Things may go crazy again, but in gold at least, nothing has really changed from a longer term perspective.

My suggestion? Enjoy the last week or so of summer. Don’t sit in front of the screen waiting on the next big thing. Stay flat for the next week and watch how things play out before taking any strong stances. Historically gold sees more activity after Labor Day than in late August. I think there will be some interesting stuff forthcoming in this market, and I will write more if I see anything take place that creates a potential for a good trade. For those updates, please check in at Fiatgold.blogspot.com.

Gold Update by Ben Ryan

August 9, 2015

I just wanted to update what has happened since last post, and why I think copper is worth a close look.

Above is the 20 day of copper with gold in purple tracking it. Since gold dropped below copper 3 Sundays ago, you will see gold has traded below copper on this scale for almost the entire time. Now, you are seeing gold hovering above copper.

There are a few ways one could interpret this action, but my main takeaway is that if this correlation is staying in tact,we will probably expect gold to sell off small or for copper to rally.

On tonight’s open Copper gapped down about 1.5 cents.

Copper filled the gap, and now sits right near where it opened. China had a few below expectation economic releases this weekend.

(http://www.bloomberg.com/news/articles/2015-08-08/china-s-exports-drop-as-external-demand-fails-to-offer-relief)

I was curious to see if it might lead to any liquidation in the metals. Copper got knocked down but as mentioned has held up. The question is, is this just a short term rally with a greater trend of selling behind, or was it just one small order at an illiquid time? To be fair, this is not an enormous move (it’d be the equivalent of gold opening down 6-7 dollars on the open). Nonetheless, I want to stress the importance of anyone trading this market on a short term basis to at least keep an eye on copper.

Gold’s ability to withstand multiple tests of the 1080 area has created some short term support. As such, there may be some short term traders playing this market from the long side. While I do not have a strong 2-3 day view on gold, I could understand why some short term traders might look to get long between 82-90 area. I would just caution, if you see copper begin to sell off, take note. It might be the signal that allows you to save a lot of money by flattening out should copper lead the way. If copper struggles to stay above tonight’s open over the course of the next few days, I would become more cautious as a gold long.

As for the trade I mentioned last time; I had said gold could be sold around 1095 with a target of 1000. I think the trade is the most reasonable out there right now given what I believe to be a very comfortable stop at 1148 lets call it. So, 95 dollar target to the downside with a stopout 53 higher. It’s not the greatest risk reward ever, but I think resistance is so strongly defined near 1140 that a breach of this level would clearly mean being short no longer made sense. For someone who has a short bias, I think that is the smart way to play it for now.

If you are more selective in looking for good spots (and that is a good idea, making directional bets in the middle of our newly defined 1080-1104 range is not ideal) then I would look to see if gold can rally first and then sell into it. If for instance you were able to sell some gold around 1105, that trade gets you 105 profit potential vs 43 downside potential. A little bit of patience for a trade that is designed to last a few weeks could do a lot for its risk return profile. While I’d like to see gold whipping around, the price action of late makes it tough to get too strong with opinions in this spot. If gold manages to go below 1080 and sit for a few days between 1070-1180; I think there will be an  an even better risk reward trade from the short side (sell 1075, stop out 1100, target 1000).

As far as trading gold goes, I find that it is better to be a little bit more patient and deal with missing a trade than to worry that you are going to miss the next big move. While I try my best to write about what I see as the determinants of good risk/reward situations, the price action can be very choppy in gold. While there is a longer term downtrend in tact, finding short term trends that allow for definitive entry and exit points has been and continues to be challenging. If you want to be short this market, keep a longer term time frame. Even in bear markets gold makes it hard for shorts with short term outlooks. You are better off scaling in on rallies, or waiting until there is a definitive break of 1080 to pile on. If you are looking from the long side, keep an eye on copper and the dollar. There has been a lot of correlation of late. If either the dollar moves aggressively to the upside or copper moves aggressively to the downside flatten out and wait for a better spot.

Have a great week,

Ben

FOMC Minutes Released, Bears still in control of Gold

Another FOMC minutes release has passed. There was the usual media excitement leading up to it, and the usual muted response from the market that follows. People get very riled up when talking about interest rates and the implications of raising them. I turned off the TV this morning when I realized that the segment was being dedicated to speculating on whether today’s minutes would include adjectives used in previous minutes releases. Apparently economists are going to have to get PHDs in linguistics if the Fed stays heavily involved in markets much longer. Let’s do a quick reality check. What does the labor market have to do with interest rates?

Most would say something along the lines of “low interest rates are important at times of economic slowness because it makes borrowing cheaper. In turn, people are more likely to start businesses, take out a mortgage, or hire new employee”. I think that comes at least somewhat close to capturing the general perception of how raising interest rates changes the economy.

If you are someone who thinks this way, I would encourage you to consider the idea that the labor market has very little to do with this, and that a 25 basis point raise would have almost zero effect on an individual’s decision to take on a mortgage or start a business. Neither would a 1% raise in the cost of borrowing.

Someone who is considering taking out their first mortgage is not concerned with 25 basis points nearly as much as they are their own sense of security about their future cash flows. Imagine a couple with a combined annual post tax income of $100k shopping for their first home. How big is the difference between a mortgage that requires $25k in annual payments and 30k?

One payment is 25% whereas the other is 30% of annual income. Is 25% clearly a reasonable amount to spend? Is 30% too much?

You can’t answer the question until you know more about this couple. If you learned that both members of the couple were high school teachers in a well to do town, the mortgage at 30% might be very reasonable. If only one member of the couple works, and he happens to be an options trader, 25% is probably too much risk.

In this example, 5% is a minor consideration among the other risk factors that will ultimately guide this couple’s decision. 25 Basis Points is only 5% of 5%. It is a rounding error when it comes to real people making real financial decisions.

So don’t buy into all this rate hike hype. We all need to be a little smarter than to take the Civics 101 explanation that the Fed minutes provide. 25 basis points is statistically insignificant to the vast majority of individual or small businesses considering taking on a loan. The question then becomes, if “labor market slack” really isn’t what is at stake with this potential rate hike, what is?

Derivatives with price sensitivity to interest rates.

While 25 basis points means little to me, it might mean the difference in millions to companies who have outstanding floating rate debt. If companies take on debt with exposure to rising rates (particularly leveraged exposure), small raises in rates could be their death knell. The derivatives market is enormous. Trillions of dollars enormous. While the gold options I trade every day are cleared on an exchange, a great number of outstanding derivatives are private deals between companies (banks, insurance companies etc). Following the economic collapse in 2008, our entire system of commerce was thrown into panic. Stabilizing the banks, and probably more importantly, their ability to meet their obligations to their creditors became paramount. When leverage gets involved, small differences in interest rates can turn into economic landmines. We cannot know for sure what  motivates Fed policy, but there are a few simple things I would suggest we all keep in mind.

1) Derivatives were at the heart of the Financial Crisis of ~2008.

2) Derivatives’ (options, futures, private contracts) value can be highly sensitive to interest rates.

3) Federal Reserve (along with the Treasury) market intervention has increased drastically since the beginning of the financial crisis.

4) The Federal Reserve sets the discount rate, which effects all interest rates, and therefore, the price of derivatives.

I am no economist, but I have traded every FOMC minutes release for the last two years, and I can say first hand that over time markets have begun to care progressively less about them. The options action in gold really tells the story best.

It used to be that hype would surround a Fed meeting, and options would get bought and volatility would firm in the days leading up to the event. If nothing happened, the options would get crushed following the minutes/meeting, and life would go back to normal. The perfectly executed strategy would involve buying options in the days leading up to the event, and selling them all and getting short right before the release. It worked for months.

Some people realized this pattern of excitement manifested in options buying was exploitable. As more Fed meetings passed, the sellers started selling earlier and earlier. Those who started buying days in advance were buying into an onslaught of volatility selling….I was one of those people at least once. At a certain point, it became clear that there was a paradigm shift.

What was once the meaningful event that brought fear and options buying to the market, has become a time for traders to sell options. In many ways it makes sense. Nothing has really changed except the warning the rate rise is happening by the end of the year. And the fact is, we’ve been told that. Does it make a difference if its next month or the month after? The only way it would fundamentally make a big difference is if the derivatives out there could somehow blow up as a result of the rate raise and cause calamity.

We might not all know about the loan exposure of a firm that is essential to our economy’s stability, but Janet Yellen does. There has been ample time (about 7 years) to let some of these contracts expire, and figure out to do with the other ones. Remember, the government bought a lot of these derivatives itself. The Fed knows what they are doing, and if they are going to start raising rates, that means it is probably safe to.

There will be no drastic economic slow downs due to a few 25 basis point bumps in the discount rate. If a lot of money moves in markets and the liquidity is not there to take the other side of orders, there could be some chaos. But the Fed has telegraphed their intentions so clearly that anyone with major blowout risk from a rate rise has had plenty of time to hedge appropriately.

As for gold, while it has made multi-year lows since breaking support at 1142, it has held its own. With managed money now net short gold, we are seeing gold hold up pretty well given the new short interest in the market. Since gold’s 50 dollar dive two Sundays ago (low 1080) gold has only managed to push 8 dollars lower, and that was met with strong buying. The trend is unquestionably down, and nothing has taken place that negates that. With open interest building from the short side, short covering rallies are always a possibility. However, resistance has been strong near 1104. In fact, while gold has spent little time as low as 1080 (the Sunday low) it has not been able to test the recovery high it made off that low that same night (see picture below).

This is a 20 day chart with each candle representing one hour of time. Notice how the move down to 1080 happened in a flash. That same night it rallied all the way back to 1118, but it has since failed to retest that high (or even get close). You can see in the chart above how I drew a horizontal line around 1086. This seems to be a pivot point for the short term chart. I see the bears as maintaining control for now because while there has been some short term support at 1086, it has been unable to hold a rally of any consequence. If it were to rally above 1110, I think you would see some short covering and a likely retest of 1130, and possibly quickly. If you are short gamma, be careful not to get caught if we trade above 1104 as I don’t see much to stop it from an extended rally if it gets above 1110. All that being said, this is just not a good risk reward here to get long. If you want to play this market from the long side, I think you want to be buying when you see the buying come in, not trying to get in front of it. For people who haven’t traded gold before, if you are impatient, don’t put anything on at all. Gold often makes you wait longer than you ever thought humanly possible.

On a longer term outlook…..

Above is the 3 year chart. Notice the big down channel I’ve drawn. The tops connect remarkably well. The bottoms look good, but right here we sit on a decision point. While it briefly broke the line two times, it has not settled below it on a weekly basis. The more gold sits here and consolidates, the more bearish it will become. If you look at the previous 3 points on the down channel you will notice that they all saw strong rallies off the lows back up to the top of the channel. If you see gold consolidate here, it will be a sign that the strong buying presence at this level has evaporated. If a longer term downtrend like this were to break it could lead to a drop of hundreds of dollars rather quickly. However,  there are multiple banks out there with targets of $1000 (over different time periods), and that alone makes me think there would be some medium term support at the millennium mark. If gold were to rally and put in yet another bottom at this level, 1130-1145 would serve as major resistance. A rally above ~1145 could produce a retest of the May high near 1235 (that is approximately where the top of the channel would come in if the rally took place in the next few weeks). If you want to play the market with an outlook of a couple of months, you could get short here around 1095 looking for 1000 and stopping out at 1140; While it is probably a positive expectation bet in this spot, I personally will be watching the price action into at least the middle of next week before taking any strong directional stance.

OptionsCity Expects Strong Interest for Nasdaq Energy Futures on First Day of Trading

MEDIA ALERT:

OptionsCity Expects Strong Interest for Nasdaq Energy Futures on First Day of Trading

July 24, 2015 – CHICAGO – OptionsCity Software announced that its clients will begin trading and market making in Nasdaq Futures (NFX) today, the first day products are available.

“Since Nasdaq’s announcement, we’ve seen strong interest from our client base of professional traders and market makers. We expect that interest to translate to trading volumes over the upcoming months,” said OptionsCity CEO and cofounder Hazem Dawani.

“More broadly,” Dawani added, “products are increasingly fungible between exchanges. To professional traders and market makers, identifying fleeting opportunities where they exist is key to success, making it more important than ever to have one technology capable of monitoring positions and executing trades.”

Combining OptionsCity’s robust trading and risk management software, Metro NOW, with new opportunities at NFX, futures and options traders can easily deploy the strategies that best meet their needs.

In March, Nasdaq announced that OptionsCity was a preferred independent software vendor for NFX. OptionsCity has since been working with Nasdaq on ensuring Day 1 connectivity to the new exchange.

About OptionsCity Software
OptionsCity Software powers the trading, risk management and analytics needs of futures and options traders, market makers, financial institutions and other market participants worldwide. OptionsCity is a certified Independent Software Vendor and a leading source of electronic options trading volume on global derivatives exchanges. For more information, please visit www.optionscity.com.

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CME Messenger now integrated with OptionsCity Metro

CME Group and OptionsCity have now integrated OptionsCity Metro pricing and risk models directly into CME Messenger (formerly Pivot).

As OptionsCity has become the industry gold standard for options on futures pricing, analytics and risk management, the integration with CME Messenger allows traders to simplify their workflows and take advantage of more opportunities in the marketplace. CME Messenger is an advanced instant messaging platform designed for traders and brokers. By connecting automatically to users from an AOL, Yahoo or Microsoft Lync profile, it allows for IM network aggregation from a single instant messaging application.

CME Messenger provides a unique, natural language parsing function in commodity markets that automatically breaks down each instant message as it is sent or received and displays them in a market monitor window. For trading firms, this is particularly helpful in managing the hundreds or thousands of IMs received each day from their brokerage community. The instant message is broken down into its components for easy visualization. Once the IM has been converted to data, it is integrated with OptionsCity Metro for instant calculation against theoretical pricing and risk models. These values are displayed in both CME Messenger as well as OptionsCity Metro, allowing traders and brokers to respond quickly and accurately to incoming requests. If a trade is agreed, they can seamlessly enter the trades into their positions in OptionsCity Metro.

For brokerage firms, a key benefit of CME Messenger is its ability to allow instant broadcasting of IMs to multiple customers all at once, saving precious time and ensuring all customers receive information at the same time.

CME Messenger is a fully compliant, secure messaging solution used across financial services customers that integrates seamlessly with all major compliance and archival applications.

CME Messenger is available for free to CME Group’s institutional customers including traders, brokers, and FCMs. For more information about CME Messenger, please visit www.cmegroup.com/messenger or contact CMEDirectSales@cmegroup.com.

New Academic Study Shows Some Option-Based Strategies Improve Risk-Return Of Long Equity Portfolios

New academic research looking over 10 years of trading shows that some options-based portfolio strategies seem to have better performance over straight long stock portfolios and improve the risk-return tradeoff over time.

The Options Industry Council recently shared the new research study, “The Performance of Options-Based Investment Strategies: Evidence for Individual Stocks During 2003-2013,” conducted by Professors Michael L. Hemler, University of Notre Dame’s Mendoza College of Business, and Thomas W. Miller, Jr., Mississippi State University. The OIC commissioned the research.

For the 10-year study, the authors looked at the relative performance of five different investment strategies. Four were options strategies: covered call (a long stock, short call), a collar (long stock, long put, short call), a protective put (long stock, long put) and a covered combination (long stock, short put, short call). They also used long equity using 10 stocks commonly used in 401(k)s.

The authors looked at performance during 2003-2013 and measured it over the entire period and during the first and second halves. They measured performance using Sharpe ratio, Jensen’s alpha, Treynor ratio and Sortino ratio.

The stocks they choose were  ExxonMobil, Comcast, Berkshire Hathaway (Class A), Oracle, Microsoft, Coca-Cola, Amazon, Wells Fargo, Google, and Apple. The researchers settled on these stocks because these shares were likely interesting to large institutional investors as “buy and hold” stocks. To avoid the potential bias when choosing stocks, they used a list of 10 from a Sept. 12, 2012 CNBC story about widely held stocks in 401(k)s. The authors said CNBC’s research came from Morningstar’s list of the top 10 firms in 401(k)s.

Hemler and Miller’s research showed that the covered combination and covered call strategies outperformed the long stock strategy, although the long stock strategy outperformed the collar and protective put strategies.

The two authors said their research is preliminary because there are a few unanswered questions, such as what is the effect of early exercise and what impact do transaction costs have on the strategies.

“We applaud the work of Professors Hemler and Miller to create greater awareness and understanding of how specific options strategies can be used to enhance investment returns as well as reduce risk in up, down, and flat markets,” said Scot Warren, OCC executive vice president of business development and OIC.

When studying the options strategies, they said they chose options that were at least 5% out-of-the-money, but with strike prices as close as possible to the opening stock price on the day strategy is initiated. They also chose options that would expire the next month. The authors also focused on monthly returns and rolled over positions each month on the last business day.

Digging a little deeper into Hemler’s and Miller’s research, the study found that the covered call strategy had lower standard deviations of return and often higher mean returns. The protective put strategy usually resulted in lower standard deviations of return and lower mean returns. The collar strategy had lower standard deviations of return and lower mean returns, while the covered combination resulted in higher standard deviations of return and higher mean returns.

“Further analysis, however, should enable us to provide stronger evidence on the relative rankings of these options-based strategies versus long equity,” the two authors said in their research.

To read the study, see: http://www.optionseducation.org/content/dam/oic/documents/literature/files/perf-options-strategies.pdf

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