October Gold is up $10.50 this morning at $1005.90 as I write. The overnight high was $1008.20, which is right on the previous February highs. The moment of truth is upon us. The large break down in the dollar bodes well for the gold bulls. The enclosed chart shows that the directional movement indicators are bullish and the ADX line is rising. Followers of this letter should be long October Gold from $964.00 and short the October ($960 strike) call option from $18.50. This is obviously a successful trade, but it is too bad that I shorted the call option. Oh well. Many books say, and my own personal observation has been, that sideways markets occur about 80% of the time and solid trending markets occur about 20% of the time, so covered call and put writing schemes should work most of the time without leaving much on the table.

This current gold trade looks as if it is one of those 20% of the time trades as we are leaving a lot on the table. That doesn’t prevent us from adding on to our gold position. I recommend putting on a ratio call spread on a price pull back. Try to buy one October Gold ($1010 strike) call option and sell 2 October Gold ($1050 strike) call options at even money (zero cost). That does not mean there is no risk. On this trade, we would make money at expiration if prices finish over $1010 and below $1090. Below $1010, at expiration, we lose zero, the cost of the spread, and above $1090, we begin losing $100 for every dollar gold is above that level.

I believe this is the best trade to enter right now with only 16 days until expiration. The maximum gain would occur if gold expires right at $1050, and the gain would be $40 per ounce or $4000. Right now it would cost about $3.00 in premium to enter that spread, or $300. I believe that with the huge rally of the past few days, that gold is bound to have a good pull back. I want to buy that pull back in price and we will try different strategies to enter every day. If anyone wants to pay a little to put the spread on now, feel free. I just want to wait for a pull back. I may change this order later on in the day.

Sep. 8, 2009
David Hall