You will seldom see a gold bug talk about using option protection, much less for what time frame and strike. I've looked at some options price history during this quarter's pm rally to find the breakeven point at which one could expect to start making money during a selloff using a long stock - partial cash / long OTM protective put strategy.

    Long May GDXJ 28 puts put on right at the top on 1/19/15, about 10% OTM and 30 delta, were going for around $3.10.  The first time down to 26 on 1/29/14, they were 4 to 4.40, so, say $4.10, or 1 point gain.   A 100 pct hedge with long puts would have been up $4000 at that moment.

    Assume the portfolio was worth $125,000 at the top.  The index sold off 15% (30.7 to 26 or so).  If one's portfolio was 60% long / 40% cash and the stocks outperformed a bit , say, down only 7.5%, that's a $5600 drawdown. 

    If one had also placed a 100% weekly , 1 point bear call spread on the GDX (50 lots or so ) at the top on 1/19/15, that would net about 30c credit.  If the short spread expired worthless, that's about $1500, which, in addition to the $4000 of the long 28 GDXJ puts, is about $5500, or essentially breakeven with the drawdown of the 60% long stocks.

    This strategy would not completely cover further losses in a continued selloff as you would have reached max gain on the call spread and the long puts would only be about 55 delta.   A more aggressive strategy such as a 100% front month costless collar (25/21 Feb GDX) right at the top on 1/19/15 would have been up almost a full 1 point at lows on 1/29/19, an increase of an additional $5000, and the portfolio would already be making money as it went lower (up $9000 on the hedge, down $5600 on the stocks), with rapidly increasing profitability as the delta on the puts rose.

    Assumptions - 1) Stock pct drawdown  -Having looked at the high to low of a few stocks in the GDXJ 2015 Model Portfolio, during that 10 day selloff,  they averaged about 8.8% drawdown (NG, SBGL, SMF.to etc).  The 7.5 % drawdown figure isn't totally unrealistic.

    2) Trade location on the protective puts and other hedges. - Moving protective puts is an expensive proposition, and if one is following a rule of moving the "stop loss" / protective puts up when the index reach marginally new highs, you'd probably leave a few percent on the table if the index moved to between 10 and 20% above your put location after your most recent move.   From 10% above on down, the assumptions appear to be valid, at least within a relatively short time frame before the puts decay.  

    Putting on weekly bearish weekly call spreads in 2 steps across a typical trading range should net at least part of the gains.  Collars would probably be put on a bit lower than expected apex of the rally, with the expectation of raising maximum cash and booking a loss on the collar should price get to the apex target.  Typical GDXJ rallies can run 35-50%.  Raising 10% cash each 10 pct increase between 60 to 100% of an expected range, along with increasingly bearish hedges, would put one in a position to achieve the above outcome in a drawdon after a rally such as we've had this year.

     

    TRIM - The chart below is marked up to show the rebalancing points I suggested in the previous note.  In particular, when in the upper half of a likely rally range (loosely defined by previous long-term support / resistance and typical rally magnitude), moving 10% to 1x physical gold or fiat at each 10% marginal increase in the index would get one to the 60% long stock / 40% fiat levels we suggested would be necessary to avoid almost all negative effects of a drawdown.  I marked those points with the green arrows and approximate dates on the upper left. 

    TRAIL - At the same time, one would "trail" by rolling up, and perhaps out in date, on the OTM long puts.  The most overbought and opportune times to do the t & t , of course, do not always correspond to exactly 10%, so one may have to bite the bullet and do another move than one would like to keep protective puts nice and tight for the inevitable sharp pullbacks.  I think I moved 4 times and had over 5 points invested in the long puts in portfolio so far.  However, the long puts currently in play (May 28) are at about 4 points in value.  Moreover, we are able to use the sharp pullbacks to our advantage and sell shorter dated put spreads to recover this protective put cost (legging into diagonal - indicated by shaded green box areas).  I'm pretty sure we're net profitable on them to this point.

    For instance, I don't show it on this chart (it is a bit idealized, showing moves of 10%), but I believe we had moved the puts to the 26 level on the first move up to 28 (1/6/15 or 1/12/15 for sure).  The  first several sharp moves back to 26 gave great opportunities to sell the Feb 25 / 20 bull put spread, for about 1 point.  Using live stop loss orders of 10% would have knocked out long positions on 1/14/15 and 1/26/15.  The rinsedown on 1/8/15 was also about 8%. 

    Using protective puts actually adds value on those pullbacks and gives one a relatively conservative "buying" opportunity by selling the short put spreads below the now near or in the money long puts.  Note, at those points the index was trading at or above the 20 dma, with strong buying in place.  That is not the case currently, with all the earnings gapdowns and short-term ma's negatively aligned.  To me, we actually crossed a significant inflection point mid-day Thursday, with very bearish short-term implications unless we take back that area with a higher low (SBGL chart below).

    SELLING WEEKLY CALL SPREADS AND USING OTHER BEARISH OPTION VEHICLES

    These decisions are a bit trickier, but we can study the historical data to see how far away from certain moving averages (9dma, for instance) the index tends to get at its most overbought points.   Looking over the last few years, it appears the GDX is at an extreme at around 10% above the 9dma, and the GDXJ would run about 13%.  Typically, waiting that long wouldn't trigger many trades, but using 1/2 positions would allow for a profitable scale-in at, say, starting at 5-7% above the 9dma for the GDX.  Should both those positions go to max loss, then a more bearish trade such as the costless collar or ITM put would be favorable, along with higher levels of profit-taking.

    GDXJ 2015 Model Portfolio 9-week review - 

    1) Initial stock selection was pretty good, with the 50% allotted to GDXJ type stocks mostly well-outperforming.

    2) The initial mix was lower beta (some royalty stocks and 2x ETF) than the GDXJ since it was all plopped in at once.  Thus it underperformed overall for a few weeks.

    3) The subsequent decisions to roll to higher beta did not work as those stocks have been mixed and mostly sagging lower in the past month.

    4) Cash levels were  too low to avoid the current drawdown of about 10% (24% max increase to current 14%).  In part, we were looking for a longer-term run into the March or May FOMC meetings, typical time frames for peaks  in many years.  This may still happen, but, hey, if you're a bankster, why go to 33 on the GDXJ from 30 when you can go through 25 first.

    5) Some weekly options plays were put on too aggressively, negating our ability to fully capitalize on the sharp pullbacks.

    6) Using seasonality (pre-Santa Claus rally) to start with a fully long, yet largely hedged portfolio was key.  It would be very easy to be losing money on pm stocks this year if one had waited to chase it after waking up from a New Year debauch, etc.

    Great info.  Thanks for sharing

    Posted by wowten on 23rd of Feb 2015 at 10:35 am

    Great info.  Thanks for sharing your analysis.

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