Use Call Spreads to Invest in Gold (GLD)

gold gld

Investor interest in gold has been high during the last few months, driven by the global healthcare crisis, low interest rates and U.S. equity markets lofty valuations.

Accordingly, gold prices have sharply increased in the last few weeks and now stand at historical highs.

GLD, 1-year. Source of Data: Yahoo! Finance

A popular way of investing in gold is the SPDR Gold Trust (GLD) ETF. It foregoes physically holding the metal and has ample price transparency and liquidity.

Listed options in GLD trade in lots of 100 shares of the ETF. Expirations range from a few days to close to two years. With GLD trading at about $185, at the money call prices range from about $5 dollars for a 1-month expiration, up to $16 dollars for a 1-year expiration.

Buying GLD call options provides leverage and limits maximum losses to the amount of premium paid. The main drawback for call buyers is the cost of the option. If gold fails to appreciate, the strategy can cost investors their full premium.

The call spread strategy

Call spreads are an alternative strategy, providing directional exposure to GLD price increases at a reduced premium cost. They involve buying a call and simultaneously selling a higher strike call. Both options are for equal GLD units and have the same expiration date.

The maximum payout of a call spread is the difference between the strikes. Compared to vanilla calls the main drawback of call spreads is their limited upside potential.

The strategy is also motivated by relative high premiums for out of the money calls when compared to lower strikes. Gold is a haven in volatile times, and demand for out of the money calls is higher than for lower strike options.  In technical terms, the cost of gold is skewed toward higher strikes.

Compare the three months premium of a call with its strike located $10 out of the money (195 strike) to that of a put struck $10 out of the money (175 strike).

Both strikes are at similar distances ($10) to the current GLD $185 price, but the 195 strike call costs $4.17, and the 175 put costs $2.90. This bias carries across expirations.

Call spread examples

The maximum payout of a call spread is the difference between the two options strikes. Buying a $185 (at the money) call and selling a $195 (out of the money) call has a maximum combined payout at expiration of $10, which is the payout when GLD expires above 195.

At the money to out of the money call spreads — GLD = $185

Tenor Expiration 185 Strike Call (Premium Paid) 195 Strike Call (Premium Received) Net Spread (Premium Paid)
1 Month 9/4/2020 -$5.15 +$2.00 -$3.14
3 Month 10/16/2020 -$7.40 +$4.17 -$3.23
6 Month 1/15/2021 -$11.00 +$7.70 -$3.30
12 Month 7/16/2021 -$16.15 +$12.75 -$3.40

When held to expiration, there are three relevant scenarios for the payout:

  • If GLD expires at or above the high strike (195), the call spread payout is $10.
  • If GLD is below the low strike (185), the call spread payout is zero.
  • If GLD expires above 185, and below 195, the payout is the difference between the price at expiration and 195.

Compared to a 1-year call, per dollar of premium spent, the strategy provides a higher return at expiration GLD prices below 232.5.

Out of the money strikes — GLD call spreads

Tenor Expiration 200 Strike Call (Premium Paid) 210 Strike Call (Premium Received) Net Spread (Premium Paid)
1 Month 9/4/2020 -$1.30 +$0.57 -$0.73
3 Month 10/16/2020 -$3.20 +$1.92 -$1.28
6 Month 1/15/2021 -$6.55 +4.80 -$1.75
12 Month 7/16/2021 -$11.40 +$9.15 -$2.25

Above are higher strike call spreads with lower net premiums. The likelihood of the strategies producing a positive payout is reduced because the strike is further away from the current GLD market price.

Note the leverage of up to five times in payouts above the high strike.

How much GLD is expected to move and over what period of time, and the capital allocated to the strategy, are key considerations in choosing the expiration date of the strategy and strike location.

5 Best Stocks to Buy If Biden Wins the Election

If Vice President Joe Biden wins the election on November 3, 2020, you might want to consider adding these five equities positions to your portfolio: XLU, TSLA, XLV, MLM, and

TGIF — Ending the Week with a Whimper

Everything is proceeding as I have foreseen. In Monday's "The Week Ahead — 200,000 Deaths Weigh Heavily on the Market," we knew the 200,000th American death would put Covid back

Even If the Overall Market Continues Lower, This Staple Could Maintain Its Upward Trend

Since peaking in early September, the main indices have all three stumbled for the last few weeks with the S&P and Nasdaq falling over 10% from their highs already. Three

tesla stock

TSLA Too Volatile? Two Option Strategies for Tesla Stock

Tesla Inc. (TSLA) is one of the most popular stocks amongst investors. Led by CEO Elon Musk the electric vehicle manufacturer has disrupted the transportation industry, bringing hype to a

pot stock

Pot Stock ‘Blood in the Streets’ Buy Signal Is Here

The cannabis market has been a volatile space in recent years. A wave in legalization, particularly in Canada but also through parts of the United States, led to significant growth

Use Options as Portfolio Insurance in Rocky Times

Since the beginning of September we have seen the main U.S. indices drop. There are a number of possible reasons for the decline, but more importantly I expect the increased

4 Foreign Countries Where You Can Retire On Social Security Alone

Someone once said that retirement is not the end of the road but a highway opening to a new chapter in life. Whoever said that clearly has never experienced a

We’re Beating the Index Off the March Low: Update

The Bulletproof Wealth Report model portfolio is continuing to perform well and is now up 27.4% since the inception of our monthly newsletter on April 13, 2018. Although the value

Terrible Tuesday: Fed’s Powell Says U.S. Faces Slow, Uncertain Recovery

Powell testifies before Congress today. We already know what he's going to say though, as his testimony is pre-released. Not that that will stop the market from acting shocked when

5 Best Online Banks, Highest Savings Rates for Your Buck

Finding an online bank can be difficult. Varying rates, hidden fees and simply having too many choices can cause confusion and make it hard to get started. Set aside some

Hiring a Financial Advisor: What Is a Fiduciary, and Why Should You Care?

“Fiduciary” is a funny word. You may have never heard of it until now, but you may actually have had a fiduciary in your life. More importantly, you may wish

Trading Cryptocurrency Using Limit and Stop Orders

This is the last of a five-part series to help new investors and traders start and grow a cryptocurrency account. In all five articles I’ve been using Bitcoin (BTC) in