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The Coming Gold Correction: Two Ways to Play the Move

Today's Financial News - Posted November 25, 2009

Karim Rahemtulla, resident options expert at Investment U, examines how to play corrections in the climbing gold market.

Karim Rahemtulla (Investment U):
Of all the great investments you could have made in 2009, gold is right up there among the best of them.

The price of gold has surged this year, taking gold shares upwards with it. Readers of my Xcelerated Profits Report have rung the register with 45% profits on Goldcorp (NYSE: GG) and a triple-digit winner on Golden Star Resources (NYSE: GSS). We’re also up big on Yamana Gold (NYSE: AUY) at the moment.

All is good, right?

On the surface, perhaps. But not if you believe what the options market is saying…

Yamana Options Signal a Share Price Drop

Using Yamana as an example, the options market is betting that over the next 12 months or so, Yamana may fall from current levels of around $13 back into the single digits again.

Just take a look at the January 2011 $7.50 put options (the right to sell Yamana shares at $7.50), currently trading at $0.70 cents per contract. This means the put buyer thinks Yamana’s price will fall to $6.80 – almost 50% below current levels – in order to be in the money. The $6.80 price is derived from subtracting the price of the option from the strike price ($7.50 minus $0.70 = $6.80). This tale is similar across other gold shares, too.

These put options are expensive relative to Yamana’s share price – the result of gold prices moving sharply in previous weeks and causing the volatility in gold stocks to increase.

As a quick refresher, the price of an option is based on four major factors:

The price of the underlying shares
The options strike price
The time to expiration
The volatility of the underlying shares
Two Ways to Play Gold Prices… But Only One Viable Option

So if you’re a gold investor looking to participate in the market, what can you do to protect your profits, or buy shares at a lower price? Here are two potential ways…

If you own gold shares at the moment: Buy put options to protect your profits.
If you don’t already own gold shares: Sell put options to lock in a lower price for your shares and get some cash from the bargain, too.
However, only one of these options is viable right now – at least with Yamana anyway.

Click here for the rest of Mr. Rahemtulla’s analysis, posted at Investment U.


Next Article: Harley’s “reverse” strike pays off

Posted by Karim Rahemtulla · Filed Under Options 

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