NEW YORK: Options traders are betting that gold will run toward $1,200 an ounce by year end, but it looks like they will have to sweat out some extremely choppy markets before seeing if the prediction pays off.
Buying of cheap calls has been one of the strategies for gaining exposure to gold, which has been one of the few commodities to prosper as a safe haven during the scariest stock market rout in memory.
Call options confer the right but not an obligation to buy something, in this case the December gold futures contract, at a predetermined strike price and date.
COMEX December $1,200 call options currently have 24,000 contracts of open interest, by far the most popular among all the different strike prices. The second highest were the $900 calls with 18,000 lots, followed by the $1,000 calls with 17,000 lots.
A put confers the right to sell something at a particular price and time.
When heavy interest lines up at a particular strike price, it can indicate where the underlying market is headed, or at least where options traders think it is.
The hedging by options desks to make sure they can sell or buy an instrument if the option is exercised can force the underlying market in the direction of the strike, especially as it nears expiration.
A relentless sell-off that pulled the U.S. stock market down about 20 percent this week bolstered gold's status as a safe store in times of financial chaos, driving bullion $200 higher in just a month's time.
"Gold is seen as something real to hold onto during times of panic," said Rob Kurzatkowski, futures analyst of optionsXpress in Chicago.
Out-of-the-money call options, where the underlying price is well below the strike, are priced much cheaper than near the money calls. This signaled the price volatility of gold will likely stay at an elevated level in the near term, option traders said.
OUT-OF-THE-MONEY BARGAIN
Kurzatkowski said that the prices of near-the-money calls have been bid up due to increased volatility, prompting many investors to buy the cheaper December $1,200 calls as a way to profit from gold's upside potential.
A single lot of December $1,200 call option costs $9.00, compared with $60 of the on-the-money December $900 call. The difference is due to gold's high implied volatility, a statistical measure of the expected magnitude of gold futures price movement given an option price.
"The volatility would suggest that the option premiums are pretty high," said David Rinehimer, director of Citi Futures Perspective in New York.
The market's actual volatility was illustrated by gold's massive $108 swing on Friday that included a $65 loss.
Kurzatkowski said he expected gold to rise to $1,000 soon should mounting fears on banks and a global recession continue to pummel the stock markets, but a sudden resurgence of the dollar could limit bullion's rally.
Jonathan Jossen, a COMEX gold options floor trader, said that volatility in gold prices has "exploded" on Friday, as measured by the frantic activity in the options market.
Jossen cited heavy buying of the December $1,200 calls against gold futures, and bull call spreads between $1,000 and $1,200 calls -- both strategies are betting that gold prices will remain volatile.
A bull call spread involves buying a lower strike price call and selling a higher strike price call, and profits are maximized when prices rise above the higher strike price.
However, option traders said it was very difficult to predict gold's next move due to hectic options activity as panic investors sought a haven amid stock losses.
"Options are like stocks now, and everybody is trading us like they are trading any other investments. This product is not used to having so much demand," Jossen said.
