Name That Trade – $GDX: I Ain’t Sayin’ Squeeze a Gold Digger

by Dan August 10, 2015 4:07 pm • Commentary

I have no idea why gold goes up or down. I get the reasons and correlations investors believe underlie the shiny metal’s movement, but none of it seems logical to me on fundamental terms so I can’t add any value there, so I only view it in technical terms. One guy who does add value is Larry McDonald, the Head of U.S. Strategy at Societe Generale. In his notes to clients over the last couple weeks has made a strong case for an impending bounce in the Gold Miners (GDX).

On July 2oth in an email to clients Larry highlights the recent history of sharp bear market rallies in the GDX from very oversold conditions, suggesting that 2015 could shape up fairly similarly:

Bear Market Rallies

May – September 2012: 35%

June – September 2013: 39%

December – March 2014: 41%

November ’14 – March ’15: 36%

July 2015 – Future: ???

On that same day, one trader took note, and looked out September to express a bullish view.  When the GDX was $14.15 (right where it is today as I write), a trader paid 25 cents for 25,000 of the Sept 16/18 call spreads to open. The trade breaks-even on the upside at $16.25, up 15%. The max gain of the trade is $1.75 if the GDX is $18 or higher, or up about 27% on Sept expiration.

Recently, options prices have exploded, with Sept at the money options sporting implied volatility of about 46%, up nearly 50% in a month, a period that has also seen realized vol (how much the underlying is moving) pick up dramatically (albeit in a tight range) has spiked, making long premium directional trades a tough way to make money.

[caption id="attachment_56015" align="aligncenter" width="600"]GDX 1yr chart of 30 day at the money implied vol (blue) vs realized vol (white) from Bloomberg GDX 1yr chart of 30 day at the money implied vol (blue) vs realized vol (white) from Bloomberg[/caption]

But GDX options are what traders would call dollar cheap.  So if you think that 2015 won’t be too different for the GDX, with an oversold condition leading to a massive counter-trend rally, then you might want to try to find the least expensive (in premium terms) way to play for a bounce back above the breakdown at $16.50 in the coming months:

[caption id="attachment_56016" align="aligncenter" width="600"]GDX 3yr chart from Bloomberg GDX 1 yr chart from Bloomberg[/caption]

I would say its nuts to step in on a day like today with the etf up 6% on what feels like a euphoric no news day. Addiitonally that implied vol spike makes things even more difficult. We will consider buying a call spread in Sept or Dec only if we see a pullback in the shares coinciding with implied vol settling. If vol continues higher we’d look to possible buy the ETF on a pullback and sell an upside call against it.