On 4/18, I wrote an article titled “Kaeppel's Corner: Gold Stocks, Dual Personalities and the Month of May” (do NOT attempt to say that three times fast) http://www.optionetics.com/marketdata/article.aspx?action=detail&aid=24347 which highlighted the general tendency for gold stocks to rally in early to mid May. As I pointed out in that article, this is by no means a “sure thing”, so many investors would likely not feel terribly comfortable risking a whole lot of money on gold stocks based solely on the calendar. Which even I have to admit is reasonable.
Still, if our goal as traders and investors is to make money, does it also make sense to consider potential ways to take advantage of given seasonal trends, so long as we manage our position to keep risk to a manageable level? Come on, admit it, that makes sense too. So with the (potentially) favorable seasonal period for gold stocks upon us, let’s consider some possibilities.
A Quick Review of Period Results: May TD 2 through May TD 15
MayTD2-15 (short for May Trading Day 2 through May Trading Day 15) – this refers to the period made up of the 2nd through the 15th trading days of May. For the record this period begins at the close on the first trading day of May and extends through the next 14 trading days (not calendar days). So this year that period – for better or worse – extends from the close of trading on Tuesday 5/1 through the close of trading on 5/21.
The MayTD2-15 period has showed a bullish tendency over the past 23 years. To note:
- Up 15 times; down 8 times
- $1,000 invested in FSAGX only during this period grew to $2,042 (+104.2%)
- Median result: +5.2%
- Maximum gain: +22.3%; Maximum loss: -12.5%
- If FSAGX registered a loss over the previous 21 trading days as of April 30th (which was the case in 2012) then MayTD2-15 was up 10 times and down 3 times.
- If FSAGX registered a gain over the previous 21 trading days as of April 30th then MayTD2-15 was up 5 times and down 5 times.
So in a nutshell:
-Gold stocks are oversold.
-The 21 day trading period ending April 30th registered a loss.
-We are entering a seasonally favorable period.
Does any of this "guarantee" an impending advance? Nope. But it sure looks like a reasonably good setup. So let’s assume that a person wants to enter a position that can make some money if gold stocks go up over the course of the next several weeks. He or she has several (Warning: extremely lame trader geek joke to follow) “options” (options, get it? Oh my God, my kids are right about me!) to choose from.
Choice #1: Buy shares of ticker GDX
GDX is an exchange traded fund that tracks the price of gold stocks. As of the close on 5/1/2012 GDX closed at $46.50. So the most straightforward approach would be to buy 100 shares at that price for a cost of $4,650. The risk “curve” (such as it is) for this position appears in Figure 1. For the record it appears as a straight line simply because if the shares go up a point then the position makes $100 and if it goes down a point the position loses $100. Like I said, pretty straightforward.
Figure 1 – Risk curve for long 100 shares of GDX position
Choice #2: Use a “Stock Replacement” Strategy
The one drawback to the previous position is that it requires $4,650 of capital to enter. An alternative is to use the “stock replacement” strategy and buy a deep-in-the-money call option as a proxy, or replacement, for the stock shares. Specifically, we will look at buying one GDX June 40 call for $6.95, or $695. This position has a “delta” of roughly 90, which implies that at the moment this position will behave like a position holding 90 shares of GDX. In other words, it will pretty much move point for point with the stock shares. With one important difference. Instead of putting up $4,650 to buy 100 shares of GDX, we are putting up just $695 to buy the June 40 call option.
Figure 2 – Risk Curves for Long GDX June 40 call
So to sum it up as succinctly as possible, we get roughly the same “bang” while committing only about 15% as much “buck” as the person who buys 100 shares of GDX.
Choice #3: Playing for a Meaningful Advance
Now if I were smart I would stop with the previous example. But truth be told, I’ve never been the sharpest knife in the, um, you know, that thing that holds the knives. I also tend to figure if I am going to play the upside I might as well at least consider going for a little bit of “gusto.” So let’s consider one other possibility that you evil speculators out there (and I think you know who you are) can consider.
This position involves buying two GDX June 47 calls at $1.78 a piece (or $1.78 x 100 x 2) for $356. This option presently has a delta of 48, so if we buy two options then the total delta is 96 (which is pretty darn close to 100), which means this position – for the time being (remember that deltas can change over time) – will also behave much like a position of 100 shares of GDX.
Figure 3 – Risk Curves for Long Two GDX June 47 calls
The Net Effect
The cost for each position is:
100 shares of GDX = $4,650
1 June 40 call = $695
2 Jun 47 calls = $378
The expected dollar profit or loss for each position as of 5/21 based on a given price for GDX at that time appears in Figure 4.
|
Stock Price as
of May 21
|
Long 100 shares
of GDX
|
Long 1 Jun GDX
40 call
|
Long 2 Jun
47 calls
|
|
42
|
($450)
|
($426)
|
($330)
|
|
44
|
(250)
|
(265)
|
(274)
|
|
46
|
(50)
|
(82)
|
(146)
|
|
48
|
150
|
112
|
62
|
|
50
|
350
|
303
|
347
|
|
52
|
550
|
504
|
687
|
Figure 4 – Expected $ Profit (Loss) as of 5/21
Summary
So let's create a short checklist:
-Are you willing to risk roughly $300 to $500 that GDX won't fall below $42 a share between now and May 21st?
If "No", then, well, thank you for reading - hope to see you again next week.
If "Yes" or even "Maybe", then the next question is which position to choose.
Which of the three I've highlighted is the best bet? Well, as they say, “Beauty” (or in this case, the relative tradeoff between potential reward and expected risk – OK, let’s just go with “beauty”) is in the eye of the beholder.
-The investor who wants roughly point-for-point movement with the underlying stock (GDX) at a fraction of the cost might prefer to buy the deep-in-the-money June 40 call.
-The investor who wants to make the most money if GDX rallies sharply might prefer the GDX June 47 call.
-The investor who thinks that options are “risky” (and don’t forget “scary”) would likely just go ahead and buy the 100 shares of GDX for $4,650.
As always, the choice is yours.
Jay Kaeppel
Staff Writer and Author of “Seasonal Stock Market Trends”
Optionetics.com ~ Your Options Education Site
NOTES:
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