Monday, December 15, 2014

GG: The Goldbug's Lament

Update Jan. 6, 2015: GG's price shot up sharply today, rising more than 7% after the company announced an unchanged dividend. The move put my options in unprofitable territory 10 days before expiration. Rather than chance a further rise, I took the loss immediately.

And a hefty loss it was. Shares rose by 9.1% over the 22 days I held the position, or a 150.2% annual rate. Most of that rise came today. My options produced a 114.3% loss on debit, for a 1,896.1% annual rate.

Prior to the price bump, GG had traced out a sideways trend that kept it out of the money, positioned for maximum profit at expiration.

Click on chart to enlarge.
GG 90 days 4-hour bars
It's difficult to formulate a take-away from this loss, beyond the simplistic and unhelpful stuff happens. The event was structured like a volatility play keyed to an event, although there was no event.

Even so, implied volatility fell just as though there had been an earnings announcement.

Perhaps the biggest flaw was the long holding time of the position. My attempts to structure shorter-term trades were stymied by wide spreads and low open interest on the Weeklys. A better strategy might have been to either pass on the trade or loosen my option liquidity standards, thereby lessening the chances of a sudden adverse price movement.

It is the simplest of stories. Goldcorp Inc. (GG), headquartered in Vancouver, British Columbia, is a gold company. Gold is in a steep downtrend. Steep downtrends have high volatility that lends itself to a certain trading strategy.

Therefore, Goldcorp is in a steep downtrend and is a perfect candidate for that strategy; in this case, a vertical options spread sold for a credit and expiring in the front month, or before if the stock has Weeklys.

GG has Weeklys. Perfection.

Of course, trading would be no fun if it were that simple, so let's dive into the weeds.

[GG in Wikipedia]


GG's implied volatility stands at 56%, the peak of its rise that began Aug. 19 from 25%. That, of course, puts volatility in the 100th percentile.

Ranges implied by options and the chart
WeekSD1 68.2%SD2 95%Chart
Implied volatility 1 and 2 standard deviations; chart support and resistance

The one standard deviation range, encompassing 68.2% of trades, suggests a potential gain or loss of 7.7% over the next seek, and the two standard deviation range, covering 95%, gain or loss of 15.5%.

Click on chart to enlarge.
GG 20 years monthly bars (left), 180 days 4-hour bars (right)

The one standard deviation range neatly covers the range from the recent low of $17.01 on Oct. 31 to the recent lower high of $21.36 on Nov. 18. A move beyond either of those two extremes would be significant in term of assessing the trend.

The view from outer space on the left-hand chart shows the magnitude of the bear market in GG, which mirrors that of the metal. Yes, we all know that gold is in a downtrend, but seeing it depicted on a chart induces a bit of vertigo, as though I were rushing along the downslope of the Kingda Ka roller coaster at Six Flags Adventure in New Jersey.

The Trade

As I mentioned, GG has Weeklys in its options inventory. My focus will initially be on the JAN1 series, which expires Jan. 2.

Open interest is less than on the regular monthly series, of course. I require triple-digit open interest in all legs of a position. With the JAN1s,  the best I can do in a bear put spread is short the $21.50 calls and long the $22.50 calls, with a 19:1 risk/reward ratio. Not acceptable.

The next series, the JAN2, expiring Jan. 9, has no triple-digit strikes among the calls.

Next up is the JAN regular monthly series, which has open interest in the four and five figures.

Bear call spread, short the $20 calls and long the $21 calls
sold for a credit and expiring Jan. 15
Probability of expiring out-of-the-money

The best I can do with an acceptable return is to go short the $20 strike, for a 3.5:1 risk/reward ratio. This covers all of the one standard deviation range but leaves 5.1% of the 2SD range and 5.3% of the chart range unprotected.

Decision for My Account

Goldbugs trading GG and other symbols in the sector are in a bit of a quandary those days. The metal has fallen so far so fast, it must near it's bottom. Right? Right?!?

The U.S. money policy committee, the Federal Open Market Committee, has had loose money for so long that signs of inflation must soon start to appear, prompting them to clamp down. Right? Right?!?

Thus has gone The Goldbugs Lament, a sad song that has provided a soundtrack for the past three years.

Happily, for this position I just care about the next few weeks. The trend is clear, and even if I'm wrong about that short span of time, the position is well hedged.

So, shutting out the lament, I've opened the position as described above. The fill wasn't entirely easy, as I had to lower my ask by 3 cents in order to find a buyer.

-- Tim Bovee, Portland, Oregon, Dec. 15, 2014


My volatility trading rules can be read here. For a discussion of the rationale behind the rules, see my essay, "Rules for very short term trades".

From time to time I use the number 68.2% in using applied volatility to calculate the expected trading range. This comes from statistics and refers to the one standard deviation boundaries, which are expected to contain 68.2% of whatever is being studied. Putting it another way, given an item (a trade or whatever), there is a 68.2% chance that it will appear within those boundaries.

My method of scoring price and volatility responses to earnings, used in the "Chart" section, is the simplest imaginable. Looking at the four most recent earnings announcements, I give one point for a rising price or rising volatility in the week after the announcement, subtract a point to a falling price or volatility, and give a zero if the response is  sideways movement. I then add the four quarters together to produce separate scores for price and volatility, and then add the two to produce a combined score. 

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.
No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decisions for his or her own account, and take responsibility for the consequences.

Creative Commons License

All content on Tim Bovee, Private Trader by Timothy K. Bovee is licensed under a Creative Commons Attribution-ShareAlike 4.0 International License.

Based on a work at

No comments:

Post a Comment