Tuesday, February 7, 2012

GOLD To Breakout After Classic Double Bottom

Gold has been volatile but overall increasing in price for years now. The question is whether gold will continue to increase in value or if it will slide down. At various price points, $1000, $1200 and $1500 analysts have decreed the end of the gold bull market.  All of these prognostications have not panned out as gold has risen to $1800. The spot commodity price of gold currently sits around $1710 per ounce.

SPDR Gold Trust (GLD) is traded on the New York Stock Exchange (NYSE). GLD is priced around 1/10th the spot commodity price of gold. As such, you can purchase GLD at about $170 when gold's commodity price per ounce is $1700. GLD appears to be making a classic Double Bottom Base, discussed below. If the price of GLD goes above $175 with above average trading volume, a high probability exists that GLD is headed for new highs!

Reed Cantor is a conservative trader who specializes in using options to augment income from blue chip investments. I met with Reed last week and we reviewed the GLD market.  He outlined a money making strategy when dealing with investments that you believe in.

To explain this strategy, I need to define a few key "trader" terms:
  • Double Bottom Base - The "W" shaped price pattern of a stock or investment in a volatile market that shakes out weak investors.
  • Handle - The short term sideways or slightly downward movement of a stock price that occurs after reaching a high.
  • Buy Stop Limit - An order to buy a security which is entered at a price above the current trading price with a limit to the price you are willing to pay. When the stop price is hit, you buy the stock at your limit price.
  • Call - The right (but not the obligation) to buy a stock, bond, commodity, or other instrument at a specified price within a specific time period.
  • Put - An option contract giving the owner the right, but not the obligation, to sell a specified amount of an underlying security at a specified price within a specified time period.

A "double bottom bases" often precedes a breakout to a new high. Handles are also often seen prior to a breakout.  The above GLD graph from Friday, February 3, 2012 shows a classic "W" shape. If it breaks the $175 previous high, point 4, with significant volume there is a high probability of a breakout to new highs.

So how can we make some money with this information?

  • Buy shares of GLD at the current market price.
  • Sell a "call" option at $175 for one week.
  • Place a "Buy Stop Limit Order." Place your buy slightly above $175 with a limit order $.03 above your stop.
We choose $175, point 4 on the graph, because it is the previous high. In this scenario, you sell the call option and capture some premium (aka take some capital gain or make some money). If the price of GLD does not rise above $175 within the call option's one week time frame, you do not have to sell your stocks and the option expires. If GLD does reach $175, you are obliged to sell your GLD, but the buy stop protects you from missing out on any large price swings to the upside. Again, a buy stop is an order to purchase shares. In this case $175.03 is a good buy stop price.

By following this strategy, an investor can continually capture premium by selling one week call options. This is commonly referred to as a covered call because the investor owns enough shares to satisfy (or cover) the call option sold. If the call option is not executed, you still own the underlying stock and can sell another call option and capture additional premium.

Reed's strategy is conservative because he only trades investments which he believes in and wants to own. This protects the investor from the worry of downside risk. Further, capturing premium through covered calls reduces any potential financial loss. If the investment does not move up or down in price (aka moves sideways) covered calls will generate steady income.

In short, this strategy builds capital in both an up or sideways market and limits losses if the investment price dips. This is a strategy that you can do in your own portfolio. It took a few days to write up this post, and gold has moved to about $1749 since Friday.  Regardless, you can use this as an example. Further, I urge you to review the silver market as an example of a handle.

For more tips on how to make money with conservative silver, gold and other blue chip core holding investments join our facebook group: Option Trading Strategies.


SarahB said...

I like gold for short term investors who keep on top of things and watch for opportunities to sell. But I still think that for the average long term investor, it is probably over valued. I always figure when you hear commercials to buy something, it's already too late for the good deals.

Commodity broker said...

I am wondering now the how soon to do the dramatic things.My work appears to be relativity stable,and I think the winds of summer might be the time we see things start to go sour here.




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