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Buzz and Banter



Kevin has presciently written several times recently on gold. The commodity itself is acting in a unique way: it is going up regardless of what other assets are doing. The gold mining stocks are acting commensurately and the option activity is indicating that the rally may not be over.

I have touched on the strategy of over-writing, when investors own the underlying stock and sell calls in an attempt to earn premium. These holders naturally only do this if they feel that a stock has for the most part run its course, at least for the time being. They are comfortable owning the stock lower, but are willing to forgo the upside. The price at which they sell these calls provides information in the short run.

An example may illustrate. With two weeks to go to expiration, an over-writer sold AU August 35 calls at $.30 with the stock at $33. This was an extremely cheap price based on the normal volatility of the stock. The stock two days before had been at $35 giving these same calls a theoretical value of $1.35. Before these calls expired the stock traded as high as $38.75 giving them an intrinsic value of $3.75. The over-writer exchanged quite a bit of upside for very little premium. But that is hindsight. The key to all this is price.

The selling of calls at cheap prices as the stocks go through the strikes leaves investors underinvested with not much for the effort. As I have stated, selling options too cheaply often creates volatility because it is a form of leverage.

With the rally in gold stocks, the option prices, probably as a function of increased over-writing activity, have gotten cheaper; not many believe in the upside. For those looking for exposure, buying out of the money calls is a good risk/reward trade.

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No positions in stocks mentioned.

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