New Trade GDX – Playing for a Bounce into FOMC

First, some quick thoughts on why long GDX came to mind this morning when I was thinking of potential trades:

Next FOMC meeting is on Oct. 24th. Since QE3 has already been announced, I expect little incremental news from this meeting. But my hunch is that it will refocus traders’ minds on the easy monetary policy, and provide a bid to precious metals AHEAD of the event
Bernanke was quite forceful in his comments at the IMF meeting in Japan this weekend, essentially ignoring the dollar depreciation effects of QE, but reprimanding other countries for holding down their currencies. Such commentary is likely to fuel precious metals buying
Gold has sold off 3% and silver 6% since their QE3 highs, and GDX is down 7%. The momentum on the recent up move was quite strong, usually indicative of a retest of the highs at some point

Here is the chart that shows that strong momentum, and I’ve also drawn a red horizontal line at the unchanged mark for GDX in 2012 (where GDX closed on Dec 30th, 2011):

The chart has a lot on it, so a quick summary:

The unchanged level on GDX for 2012 is $51.43 (horizontal red line). I think that might serve as an important pivot point for GDX over the next month, and with the ETF trading right around there after the recent selloff, the entry seems favorable.
The 50 day moving average (pink line) and 200 day moving average (black line) could act as support in the 49-50 area.
The strong overbought RSI on the QE3 announcement is circled in red. It’s rare to see an asset sell off straight after such an overbought reading without a revisit to those highs.

Finally, gold miners have been hurt this year by increasing cash costs on their mining projects, even though gold and silver are both up substantially since the start of 2012. However, one recent benefit has been that the selloff in oil has not been accompanied by a selloff in precious metals of the same magnitude. In addition, emerging market economic weakness has reduced inflationary pressures, particularly for wage costs for miners going forward.

Here’s the trade:

Trade: GDX ($51.17) Sold Nov 52 / 49 put spread to open at $1.30

sold 1 Nov 52 put at 2.40

bought 1 Nov 49 put for 1.10

Break-Even on Nov Expiration:

-Profits between 50.70 and 52, max profit of above 52

-Losses between 50.70 and 49, max loss of below 49

TRADE RATIONALE: The reason I chose to sell a put spread as opposed to buy a call spread is because I see a lot of potential areas of support near here, but am less confident that GDX will have a big bounce soon. In addition, GDX implied vol has rallied a bit on the recent selloff, so this takes advantage of that. Finally, I am slightly below a 1 to 1 risk / reward, but with potential support below, and only $1 of intrinsic value in the trade as of now, time is on my side.