Options traders predict gold will touch $1,200 an ounce

Reuters
Published: October 13, 2008, 00:02

New York: Options traders are betting that gold will run towards $1,200 an ounce by year end, but it looks like they will have to sweat out some extremely choppy markets before seeing if the prediction pays off.

Buying of cheap calls has been one of the strategies for gaining exposure to gold, which has been one of the few commodities to prosper as a safe haven during the scariest stock market rout in memory.

Call options confer the right but not an obligation to buy something, in this case the December gold futures contract, at a predetermined strike price and date.

Comex December $1,200 call options currently have 24,000 contracts of open interest, by far the most popular among all the different strike prices.

The second highest were the $900 calls with 18,000 lots, followed by the $1,000 calls with 17,000 lots.

When heavy interest lines up at a particular strike price, it can indicate where the underlying market is headed, or at least where options traders think it is.

Sell-off

The hedging by options desks to make sure they can sell or buy an instrument if the option is exercised can force the underlying market in the direction of the strike, especially as it nears expiration.

A relentless sell-off that pulled the US stock market down about 20 per cent last week bolstered gold's status as a safe store in times of financial chaos, driving bullion $200 higher in just a month's time.

"Gold is seen as something real to hold onto during times of panic," said Rob Kurzatkowski, futures anal-yst of optionsXpress in Chicago.

Out-of-the-money call options, where the underlying price is well below the strike, are priced much cheaper than near the money calls. This signalled the price volatility of gold will likely stay at an elevated level in the near term, option traders said.

Kurzatkowski said that the prices of near-the-money calls have been bid up due to increased volatility, prompting many investors to buy the cheaper December $1,200 calls as a way to profit from gold's upside potential.

Single lot

A single lot of December $1,200 call option costs $9.00, compared with $60 of the on-the-money December $900 call. The difference is due to gold's high implied volatility, a statistical measure of the expected magnitude of gold futures price movement given an option price.

"The volatility would suggest that the option premiums are pretty high," said David Rinehimer, director of Citi Futures Perspective in New York. The market's actual volatility was illustrated by gold's massive $108 swing on Friday that included a $65 loss.

Kurzatkowski said he expected gold to rise to $1,000 soon should mounting fears on banks and a global recession continue to pummel the stock markets, but a sudden resurgence of the dollar could limit bullion's rally.

Jonathan Jossen, a Comex gold options floor trader, said that volatility in gold prices "exploded" on Friday, as measured by the frantic activity in the options market.

Jossen cited heavy buying of the December $1,200 calls against gold futures, and bull call spreads between $1,000 and $1,200 calls - both strategies are betting that gold prices will remain volatile.
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