Risk aversion among year-end buyers and short-covering boosted gold futures early this week, but the rally could be short-lived, with the stronger dollar keeping a lid on further gains. Gold futures jumped almost two percent, breaking above the key $1,200-per-ounce level, as traders used Tuesday’s weaker dollar as an excuse to buy.

Worries about Greece’s election outcome and tensions between Russia and the West also sent buyers into the metal.  The holiday season and the upcoming Lunar New Year celebrations in China boosted physical demand for gold (Gold is bought for good fortune and to be given as gifts.).

Investors remain bearish on gold, but prices have been relatively less volatile in 2014, compared to the 28 percent slide and $500 trading range in 2013. For this year, gold has lost 0.3 percent and traded in a $260 range, although prices fell to a 4-1/2-year low in November. Holdings in SPDR Gold Trust, the world’s largest gold-backed exchange-traded fund, however, remain weak. On Tuesday December 30th, holdings fell 0.21 percent to 710.81 tons, a six-year low.

The stock market has been the investment of choice for 2014 again, followed closely by the US dollar. Interestingly, this hasn’t aided gold’s fortunes to the upside. However, last January was the worst month of the year for the stock market, as fund managers booked profits at the beginning of the month and quarter to pay themselves hefty performance bonuses.

The Set Up

In that environment, gold rallied from multi-year lows to post sizable percentage gains through February. We could see the same scenario this year. Conversely, if stocks and the dollar continue to rally through January, it is my contention that gold will retest or make new lows soon.

From a trading perspective, I remain agnostic. Gold’s price dip on December 31st is an opportunity to employ an options strangle strategy to capture a potential significant move in price.

The Trade

  • I would look at buying the March Gold 1250-1300 call spread and at the same time buying the March Gold 1100-1050 put spread for a price of 10 points or in cash value, $1,000.00.
  • The risk on the trade is the price paid for the option spreads plus all commissions and fees.
  • If the underlying futures price settles over 1300 or under 1050.0 an ounce, one would collect $5,000.00 at option expiration.

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RISK DISCLOSURE: THERE IS A SUBSTANTIAL RISK OF LOSS IN FUTURES AND OPTIONS TRADING.  THIS REPORT IS A SOLICITATION FOR ENTERING A DERIVATIVES TRANSACTION AND ALL TRANSACTIONS INCLUDE A SUBSTANTIAL RISK OF LOSS. THE USE OF A STOP-LOSS ORDER MAY NOT NECESSARILY LIMIT YOUR LOSS TO THE INTENDED AMOUNT.  WHILE CURRENT EVENTS, MARKET ANNOUNCEMENTS AND SEASONAL FACTORS ARE TYPICALLY BUILT INTO FUTURES PRICES, A MOVEMENT IN THE CASH MARKET WOULD NOT NECESSARILY MOVE IN TANDEM WITH THE RELATED FUTURES AND OPTIONS CONTRACTS

 

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