Gold is down 22% from its early October high and people are scrambling. None of the fundamental reasons supposedly favoring a continued rally in metals have proven true. Back in early February, when most banks still had price targets of $1800 or more, I reviewed the bull case for gold and found the arguments pretty weak. Fear of hyperinflation/central back activity isn’t an argument as much as a prophecy, and religion and investing don’t pair well; gold isn’t even a good inflation hedge in the first place. Currency volatility didn’t justify a long gold position earlier this year, and it still doesn’t: CVIX is still below mean 2012 levels even including yen weakness.
Fig. 1. CVIX – Major FX 3M IV. Source: Deutsche Bank
The May GLD strangle I recommended earlier this year paid off well, although to be honest I wasn’t expecting anything quite this dramatic. Active traders should actually favor the short vol side here. Look at the spike in one month GLD implied volatility (GVZ) as of Friday:
Fig 1. GLD and GVZ, 2012-2013. Source: CBOE, Condor Options
At pixel time, GVZ has vaulted up again, near 32. There’s no word yet on changes to COMEX margin requirements, although it’s safe to assume those changes are coming. You can monitor those requirements here. To the usual reasons for favoring short volatility positions after a spike, add the fact that higher margin requirements at the exchange are a forced reduction in leverage and hence in volatility.
My favorite trade in this situation would be a short straddle on medium term GVZ options, with a strike price of 20 or so. The volatility of GLD implied volatility is incredibly high, and unlikely to remain this high, so as vol-of-vol declines, profits are likely to accrue more quickly than usual to sellers; the downside strike incorporates the view that GVZ is just as likely to mean revert once GLD calms down as VIX does after an equity selloff. GVZ options aren’t active enough yet and the market is too wide, at least on the screen, but GVZ futures have been seeing steady activity and we’ve started a short (and admittedly early) position there. Selling cash-secured puts in GLD will also be an attractive trade once the metal finds a short-term bottom.