THE HIGHTOWER REPORT
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800-662-9346(November 4, 1999) METALS: GOLD OPTION STRATEGIES--The gold market might be headed for yet another volatility event! We would think that the "mechanical" disruption that unfolded in the September and October time frame has not completely leveled out, as many hedges were rolled upward, some were completely liquidated and, most importantly, many might have utilized the December options extensively to try and control volatility and exposure. In other words, it's possible that some hedgers/loaners have positions that are underwater and dependent on December options. The Commitment of Traders report on options and futures shows some rather large net positions still open in the December contract, so it's possible that before the November 12th expiration of the December gold contract we could see another volatility event. We would have to suggest that in the time since the October high in gold the basic fundamentals have been bearish. Physical supply has been increasing, the currency affect is negative and the hedgers would seem to have a reason to hedge forward now that prices are more palatable. We have long wondered why gold producers were interested in locking their price for gold when the market was trading down around $250 an ounce. At least with gold in the vicinity of $300 they have some breathing room above their cost of production. It's interesting that the recent gold low coincided with the May highs, the second gap on the rally at 278.2 to 295 and the heavy volume trade action that took place on between September 24th and October 5th. Actually, the fact that prices have returned to the vicinity of the volatility explosion could be another reason why we anticipate expanded daily ranges. Since there was such widespread participation in the market around the current levels, a failure below 285.5 might be a source of stop-loss selling. Furthermore, if there is such a massive call position, some traders might be forced to sell futures to protect profits gained in the big run.
Finally it's also possible that gold hedgers decided to use short calls as a partial hedge when the gold started to rally and later regretted it. If the gold market were to begin to rally into expiration, it's possible that hedgers might decide to buy futures to protect their hedges, and that could result in a massive short covering move.
In summary, we think the market is being driven move by "mechanical" factors and not classic fundamentals and that a slight push in either direction could cause a mini flare-up similar but less severe than the September/October action.
SUGGESTED TRADING STRATEGY--Buy a January 285 gold put and buy a January 305 gold call for $1000 with an objective of $2100 to $2400. Risk the option to a close below $400.
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