Building a long-term position in gold via NUGT

I and others I know have found ourselves chasing gold.  We periodically get a nice position, take our profits, and then find ourselves missing out on the next big move because we cannot find good entry.

This has been driving me nuts all year.  While I finally just bought a gold fund in my 401k in April so I never miss out on an up move again, I’m still far from fully benefiting from the continued rise in gold.

Typically, I prefer gold futures (/GC) as a vehicle.  However, they suffer from two major limitations.  They do not have weekly options, and their options only go out a couple of months.

Thesis: Target for gold is 1600 before the end of 2016.

This is a thesis I’ve held for 2016 since mid-2015.  The first half of the year sure has confirmed the thesis.  I won’t get into all the reasons gold is soaring this year in this post.  But, the positions I’m describing here are based on capturing profits if this thesis continues to prove true.

There is good news.  While gold has risen from 1060.50 since the beginning of the year, gaining over $300, or 30%, in order to hit $1600, gold has about $230+ more to go.  That’s still a nice gain to capture.

So, how do we capture it without constantly chasing price and hoping gold doesn’t soar while we ‘re sleeping in the Asia and European sessions, or looking for a pullback that never comes while it rips in front of us?

Fortunately, in addition to being a 3X leveraged ETF of gold miners with a high correlation to the price of gold, NUGT also has weekly options, and has options all the way to January covering our time frame.

There are some principles to options you’ll want to understand for this strategy:

  1. The further out in time they expire, the lower the delta and theta.  The former is good when it is going against you.  The latter is the cost of having lower short-term price volatility.  We’ll leverage this lower delta to scale our position when we think /gc could ultimately retreat quite a bit, yet know we can’t guarantee how far it will pull back either.
  2. Because we’ll primarily begin by building a position that decays extrinsic value, it is important to understand that extrinsic value is highest at the money (ATM).  The further out of the money (OTM) or in the money (ITM) you go, the less potential profit from the position.
  3. Because NUGT is a 3X ETF, it consumes a lot of buying power even for margin accounts.  We’ll address this by ultimately looking to create verticals.

Long via short puts

At 1357, and having only been in the 1300s for a short while, we view /GC as being 1/2rd through a 1300-1400 range.  Many are betting it will hit 1400 soon, and plan to short it there.  So, it has a decent probability of racing back to support near 1308.  Yet, due to the reasons it is soaring (bonds having negative returns, currencies unstable, and brexit), there is never a guarantee it will come back down that far.  We want to be sure we have a position in case it soars without an ideal pullback.  Yet, we don’t want to be too exposed in case it does drop back near 1300; and, want to be able to add to our position if it does.

Thus, at this level, we’ll begin our position with low delta short puts by going out to December expiry.  For the strike, I choose to be near the money to maximize extrinsic value.  The good thing about December is the premium is high enough to easily get a break even of $100.  Selling a 160 Dec for $55 means your break even at expiry is $105.

The delta on Dec 160 is currently -.29.  That means that the option price is expected to decrease by .29 per share for ever $1 gain in NUGT, presuming volatility doesn’t change, and not taking into account theta burn.  That is what we like being so far above what we currently consider strong support.  We’ll take a lot less heat than a put that will be expiring soon at the same strike if /GC drops $60.

Our goal is to turn this into a vertical, as we believe /GC has a high probability of shooting for $1400 before coming down.  If you are not comfortable opening a naked option position, or don’t like the buying power reduction (BPR), you can just begin with a vertical.  However, I’m choosing to open the short side first, then the long side if /GC goes higher in the near-term.

After selling this put.  I created an order to buy the 140 Dec for $20 less than I received for the 160.  If I’m super lucky, and it fills, then I just locked in max profit on the spread!  Realistically, though, I’ll look for resistance on /GC, notably 1400, and do a cancel/replace for whatever I can get then, because I anticipate a pullback there on first touch.  Regardless, it is likely to be a lot better than what I’d pay today, both because it will be worth less due to the delta, and because time will pass, burning theta.

Note that you are never locked in.  Let’s gold hits 1400, we buy the put creating our spread, then gold drops $90.  We could, at that point, close the long put for a profit, or roll it to a different strike to widen our profit potential.  The idea of putting it on is to lock in a higher probability of profit while creating some downside protection.  Once we’ve used that downside protection, we can choose to remove or reduce it.

If /GC drops before I get a chance to do it, then I’ll just be stuck with a naked put for awhile, and wait until /GC runs again.  Like I said, if this isn’t for you, you can just open a short vertical and be done with it.  I’m just trying to maximize potential profit and probability of profit by putting some swing trading into how the position is created.

If the naked put is a little uncomfortable, but you want to try to time the sides of the vertical, you could start with the long side first.  The down side it will be decaying while you wait for entry on the long side.  The good news is that the decay will be relatively slow since you went out to December.  That Dec 160 currently has a theta of -.16.  Contrast that to the 160 expiring in two days with a theta of -$1.30.  If you do the long side first, then you’ll be hoping for a nice pullback to complete with the short side instead of waiting for /GC to go higher.  If you feel strongly about which direction it is likely to move in the next few days, this can also factor into which side you do first.

Scaling Based on /GC price

What do we do as /GC comes down towards our major support, but isn’t there yet.  Remember, there’s no guarantee it will get there.  So, we want to balance the possibility it can just drop to 1340 and bounce and never go below it again for the rest of the year, with increasing risk and potential profit as it approaches 1300.  To do this, I’ll use closer expiries as it drops.  Perhaps Nov in 1340-55 range, Oct in 20-40 range, etc,…  The closer it gets to the bottom of it’s potential range, the more delta we’ll be willing to risk to collect more from theta burn.  🙂  This is optional.  You could stick to Dec.  I just like to increase reward/risk as it approaches support.

Note that once it gets down to 1300-15, even a short OTM put spreads can be very lucrative.  Analyze these and decide if they aren’t good option for you.  I just don’t think they are lucrative enough until /GC is down there to be worth the heat.  But, they are on my list of potential positions to open there.

Long Calls to Maximize Profit Potential

The next part of this strategy is what we’ll do if /GC pulls back near 1300, where we believe there is strong support and it will likely bounce like the last time it came near 1308.  For one, you can immediately sell short puts that expire in the near-term for quick profits on that bounce, or even if it ranges there for a bit, as theta will decay fast.  Then, take the cash you raise from that, and buy some Dec calls.  You’ll have to pick the strike you like and are willing to pay for.  But, here’s where you turn a potentially profitable position into a really potentially profitable position.  The potentials gains of Dec NUGT calls if /GC goes from 1300 to 1600 by then are huge.  The good thing is you’ve effectively financed these with short puts.

To be clear, there is a lot of downside risk to this position.  I have strong conviction so am not too concerned about that.  Yet, once your put side consists primarily of verticals, your risk will be limited.  If you timed it will, then you really reduced your risk.  If you get lucky and the difference between price you collected from short side and long side is same as spread, you have NO RISK on that spread as you already collected max profit, and will just wait for payday!


To be sure, you can use different underlyings and combine them in different ways.  The important thing is you are capturing both delta and theta burn on anticipation of an up move in gold, with little to no risk if gold doesn’t climb, and you are managing and limiting risk to the downside.  You’re also timing it to obtain the best position given the uncertainties.

Alternatives include using /GC options, GLD options, or anything else that moves with the price of gold.



Spread the love

About Erik Calco

With a passion for Investing, Business, Technology, Economics, People and God, Erik seeks to impact people's lives before he leaves. Contact Erik
This entry was posted in Investing, Trading and tagged , . Bookmark the permalink.

Leave a Reply