BANK OF AMERICA: An under-the-radar trading strategy that profits from market turmoil is at its most attractive since the financial crisis. Here's how to implement it.
- Gold has spiked to its highest level in six years amid trade tensions and high expectations that the Federal Reserve will soon lower interest rates.
- Meanwhile, the premium for certain call options that would profit from gains in the largest gold exchange-traded fund has jumped to its highest level in 10 years, according to Bank of America Merrill Lynch.
- The firm's equity-derivatives strategists formulated an options-trading strategy that would profit from continued gains in gold.
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When chaos erupts in global markets, gold is one of the assets in which investors seek shelter.
The precious metal is exhibiting its safe-haven status with a break-out rally to six-year highs.
Because gold is used as a store of value, its price has been buoyed by the serious prospect of a Federal Reserve interest-rate cut that might reduce the allure of interest-bearing assets. It's also being lifted by lingering uncertainty about the global trade war and economic slowdowns around the world.
But no market trend lasts forever, and traders can lose interest in gold as quickly as they found it. Chief among the risks to this rally is a resolution to the trade dispute during the G20 summit this weekend - a development that would allay one of the lingering concerns on investors' minds. And given that gold climbed so quickly - by more than 8% in June alone - a rollback could soon follow.
That's where the trade recommendation from Bank of America Merrill Lynch comes in. According to a team led by Benjamin Bowler, the firm's global head of equity derivatives research, it's suitable for traders who want to profit from a continued rally in gold but limit their downside if the gains discontinue.
It's pegged in the options market for the SPDR Gold Shares exchange-traded fund (GLD). Bowler observed that traders are paying a hefty premium for options contracts that bet on increases in GLD, the largest ETF of its kind. Measured as call skew, this premium is at its highest level in 10 years.
Although this premium is now at a post-crisis high, it's not rare for it to be in positive territory. After all, gold is the poster child of safe-haven assets, and a lot of buying is driven by fear and uncertainty about financial markets. It follows that options contracts betting on increases in GLD translate to bullish bets on the underlying commodity, and are bought to profit in times of turmoil.
With traders now aggressively jostling for GLD call options, Bowler recommends buying call spreads as a way to profit from further gains.
"For those wary of spending 12 months of premium on outright calls, gold call skew offers an attractive opportunity to cheapen the trade," he said in a recent note to clients.
He continued: "We like owning Jun20 140-155 GLD call spreads (43d and 23d respectively, ref. 132.9). The structure costs ~2%, a ~50% discount vs the 140 call outright, and has a max payout ratio of ~5.7x."