Gold has long held a valuable place in asset allocations for investors, especially in times of economic uncertainty. Gold provides a natural hedge against inflation and is a safe-haven investment during severe economic stress. Here's an option strategy using GLD stock that gets you gold exposure without buying physical gold.
A Synthetic Long Trade On GLD Stock
With the current uncertainty over Ukraine, the Fed meeting and lingering Covid concerns, it's no wonder gold strengthened recently. The SPDR Gold ETF went from 166 at the end of January to a high of 193 last week.
According to IBD Stock Checkup, GLD has a Relative Strength Rating of 89.
One of the frequent topics of conversation on IBD Live lately is how GLD stock is coming out of a long base that stretches all the way back to 2011. That's when austerity measures in Europe stoked fears of a global recession.
Setting up a synthetic long on GLD stock allows you to benefit from a move higher in gold. Plus, you don't need to buy physical gold and you can participate with less capital.
First, you sell an at-the-money put on GLD stock while simultaneously buying an at-the-money call. With GLD stock trading around 182.30 yesterday, the Sept. 182 put sold for 10.20 while the Sept. 182 call traded around 11.
Since you are selling the put, that's money you receive to offset the cost of the call you buy. Therefore, this synthetic long on GLD stock costs 80 cents per contract, or $80 since each contract is 100 shares.
Leverage Cuts Both Ways
For GLD stock, buying 100 shares costs $18,230. The synthetic long is a fraction of that with its $80 cost. Despite that, you still get similar exposure as owning 100 shares due to the inherent leverage in the options.
Even though the option trade only costs $80, the investor could still lose $18,230 if GLD stock went to $0. In that unlikely event, the call expires worthless and as the put option writer, you have the obligation to purchase GLD stock at 182. Of course, most investors would have a stop loss long before then.
What if GLD stock rises well above 182? Then the put expires worthless and you keep that premium. Meanwhile, your call option becomes more valuable as GLD stock rises.
The advantage of the trade is that an equivalent exposure to owning 100 shares of GLD stock is gained for only a fraction of the cost. For this synthetic long position, the margin requirement would be around $4,600. The investor could use the leverage power of options to trade multiple synthetic long positions with the same margin requirement to purchase 100 shares.
But don't forget about the magnified losses that are possible if the trade goes against you. Leverage is a double-edged sword.
Please remember that options are risky, and investors can lose 100% of their investment.
Gavin McMaster has a masters in applied finance and investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ.
