Buying Gold Put Options to Profit from a Fall in Gold Prices

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Buying Gold Put Options to Profit from a Fall in Gold Prices

If you are bearish on gold, you can profit from a fall in gold price by buying (going long) gold put options.

Example: Long Gold Put Option

You observed that the near-month TOCOM Gold futures contract is trading at the price of JPY 2,518 per gram. A TOCOM Gold put option with the same expiration month and a nearby strike price of JPY 2,500 is being priced at JPY 168.00/gm. Since each underlying TOCOM Gold futures contract represents 1,000 grams of gold, the premium you need to pay to own the put option is JPY 168,000.

Assuming that by option expiration day, the price of the underlying gold futures has fallen by 15% and is now trading at JPY 2,140 per gram. At this price, your put option is now in the money.

Gain from Put Option Exercise

By exercising your put option now, you get to assume a short position in the underlying gold futures at the strike price of JPY 2,500. In other words, it also means that you get to sell 1,000 grams of gold at JPY 2,500/gm on delivery day.

To take profit, you enter an offsetting long futures position in one contract of the underlying gold futures at the market price of JPY 2,140 per gram, resulting in a gain of JPY 360.00/gm. Since each TOCOM Gold put option covers 1,000 grams of gold, gain from the long put position is JPY 360,000. Deducting the initial premium of JPY 168,000 you paid to purchase the put option, your net profit from the long put strategy will come to JPY 192,000.

Long Gold Put Option Strategy
Gain from Option Exercise = (Option Strike Price – Market Price of Underlying Futures) x Contract Size
= (JPY 2,500/gm – JPY 2,140/gm) x 1000 gm
= JPY 360,000
Investment = Initial Premium Paid
= JPY 168,000
Net Profit = Gain from Option Exercise – Investment
= JPY 360,000 – JPY 168,000
= JPY 192,000
Return on Investment = 114%

Sell-to-Close Put Option

In practice, there is often no need to exercise the put option to realise the profit. You can close out the position by selling the put option in the options market via a sell-to-close transaction. Proceeds from the option sale will also include any remaining time value if there is still some time left before the option expires.

In the example above, since the sale is performed on option expiration day, there is virtually no time value left. The amount you will receive from the gold option sale will be equal to it’s intrinsic value.

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How To Buy Gold Options

Buy gold options to attain a position in gold for less capital than buying physical gold or gold futures. Gold options are available in the U.S. through the Chicago Mercantile Exchange (CME), so if you’ve wondered how to invest in gold, here’s a shorter-term and less capital intensive way to do it.

How to Invest in Gold: Calls and Puts

Use options to profit whether gold prices rise or fall. Believe the price of gold will rise? Buy a gold call option. A call option gives the right, but not the obligation, to buy gold at a specific price for a certain amount of time (expiry). The price you can buy gold at is called the strike price. If the price of gold rises above your strike price before the option expires, you make a profit. If the price of gold is below your strike price at expiry, you lose what you paid for the option, called the premium. (For more on how to decide which call or put option to use, see “Which Vertical Option Spread Should You Use?”)

Put options give the right, but not the obligation, to sell gold at a specific price (strike price) for a certain amount of time. If the price of gold falls below the strike price, you reap a profit of the difference between the strike price and current gold price (approximately). If the price of gold is above your strike price at expiry, your option is worthless and you lose the premium you paid for the option.

It is not necessary to hold your option till expiry. Sell it at any time to lock in a profit or minimize a loss.

Gold Options Specifications

Gold options are cleared through the CME, trading under the symbol OG. The value of the options is tied to the price of gold futures, which also trade on the CME. 40 strike prices are offered, in $5 increments above the below the the current gold price. The further the strike price from the current gold price, the cheaper the premium paid for the option, but the less chance there is that the option will be profitable before expiry. There are more than 20 expiry times to choose from, ranging from short-term to long-term.

Each option contract controls 100 ounces of gold. If the cost of an option is $12, then the amount paid for the option is $12 x 100 = $1200. Buying a gold futures contract which controls 100 ounces requires $7,150 in initial margin. Buying physical gold requires the full cash outlay for each ounce purchased.

To buy gold options traders need a margin brokerage account which allows trading in futures and options, provided by Interactive Brokers, TD Ameritrade and others.

Gold options prices and volume data are found in the Quotes section of the CME website, or through the trading platform provided by an options broker.

The Bottom Line

Calls and puts allow traders a less capital intensive way to profit from gold uptrends or downtrends respectively. If the option expires worthless, the amount paid (premium) for the option is lost; risk is limited to this cost. Trading gold options requires a margin brokerage account with access to options.

How To Buy Gold Options

By Cory Mitchell

Buy gold options to attain a position in gold for less capital than buying physical gold or gold futures. Gold options are available in the U.S. through the Chicago Mercantile Exchange (CME), so if you’ve wondered how to invest in gold, here’s a shorter-term and less capital intensive way to do it.

How to Invest in Gold: Calls and Puts

Use options to profit whether gold prices rise or fall. Believe the price of gold will rise? Buy a gold call option. A call option gives the right, but not the obligation, to buy gold at a specific price for a certain amount of time (expiry). The price you can buy gold at is called the strike price. If the price of gold rises above your strike price before the option expires, you make a profit. If the price of gold is below your strike price at expiry, you lose what you paid for the option, called the premium. (For more on how to decide which call or put option to use, see “Which Vertical Option Spread Should You Use?”)

Put options give the right, but not the obligation, to sell gold at a specific price (strike price) for a certain amount of time. If the price of gold falls below the strike price, you reap a profit of the difference between the strike price and current gold price (approximately). If the price of gold is above your strike price at expiry, your option is worthless and you lose the premium you paid for the option.

It is not necessary to hold your option till expiry. Sell it at any time to lock in a profit or minimize a loss.

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Gold Options Specifications

Gold options are cleared through the CME, trading under the symbol OG. The value of the options is tied to the price of gold futures, which also trade on the CME. 40 strike prices are offered, in $5 increments above the below the the current gold price. The further the strike price from the current gold price, the cheaper the premium paid for the option, but the less chance there is that the option will be profitable before expiry. There are more than 20 expiry times to choose from, ranging from short-term to long-term.

Each option contract controls 100 ounces of gold. If the cost of an option is $12, then the amount paid for the option is $12 x 100 = $1200. Buying a gold futures contract which controls 100 ounces requires $7,150 in initial margin. Buying physical gold requires the full cash outlay for each ounce purchased.

To buy gold options traders need a margin brokerage account which allows trading in futures and options, provided by Interactive Brokers, TD Ameritrade and others.

Gold options prices and volume data are found in the Quotes section of the CME website, or through the trading platform provided by an options broker.

The Bottom Line

Calls and puts allow traders a less capital intensive way to profit from gold uptrends or downtrends respectively. If the option expires worthless, the amount paid (premium) for the option is lost; risk is limited to this cost. Trading gold options requires a margin brokerage account with access to options.

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    2nd place in the ranking!

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