Alexander Valtsev
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A Non-Directional Strategy On Gold For The Next Week

Gold is a very popular instrument nowadays, especially given the fact the investors do not have to physically own gold but can, for example, buy gold ETFs or enter into CFD contracts with leverage. In the past few years, gold was in decline but it gained substantially since the beginning of 2016:


As you can see, there is significant volatility over long periods of time in this instrument, and it is unpredictable. However, I do not like forecasting price levels for instruments (for the exception of stocks, but even there I determine fair values of the stocks, not the direction of their expected movement). With metals and commodities in general I like non-directional strategies like the options strategy called iron condor, which I talked about quite a lot in my previous articles.

The choice of my non-directional idea today is SPDR Gold Trust ETF (GLD). I like this instrument a lot because it has proven to be a low-volatility instrument over the past year:

(Source: Google Finance. Calculations by author)

Its standard deviation of daily returns has averaged 15% - 18% (annualized) over the past 52 weeks. This translates into a weekly standard deviation of around 2.2% - 2.7%. We are looking at weekly standard deviation because my idea is to initiate an iron condor trade with options expiring approximately one week from now - April 29, 2016:

(Source: TD Waterhouse)

Doing the iron condor trade essentially means getting into a put and a call spread simultaneously: 


Note that I used ask prices for long positions and bid prices for short positions in order to remain conservative.

Below you can see the risk-return matrix for this trade idea:


As you can see from the illustration, the maximum amount a trader can lose in this trade is approximately $58 per contract (equivalent to 100 shares), while the maximum gain is the initial net credit balance of $142 per contract. This translates roughly into a 2.5:1 risk-return ratio, which I find extremely attractive over such a long time period.

In order for the trade to remain profitable, the underlying has to stay within a certain range (presented by green cells on the illustration). The range is between $117.60 and $120.40 per unit. A quick calculation using the Black-Scholes model shows that chances that the price of the underlying goes outside these borders is approximately 32% - 33% (assuming normal distribution of daily returns, which is quite a bold assumption):

(Source: Calculations by author)

The difference between the break-even prices is essentially the spread the investors are pocketing with this trade. Although the odds are skewed towards the owners of this position, there is no free lunch: the spread is within the one standard deviation band, as presented by historical data. Nevertheless, I am willing to take the 30% risk in order to more than double my money, if the underlying remains relatively steady. It is also encouraging to see that this ETF has moved within a very tight range ($117 - $120 per unit) over the last month.

What do you think of this idea? Please comment below, if you would like to see the relevant calculations in Excel.