I had recently posted an idea for a bear put spread on the XGD with the intention of capitalizing on a short-term pull back in gold. See  A Short-Term Directional Play on Gold Through the XGD.

The implementation of a debit spread strategy allows the investor limit their risk exposure by offsetting the cost of a long option position, with the sale of an option contract at a different strike price.

As I write this, gold has just hit a two year high, certainally comprimising the theory that gold should retrace back down to 1300.  I had suggested offsetting the position if XGD broke above $25.00 in order to limit losses (losses do occur from time to time in this business).  We saw a breif consolidation at this price level, before the ETF gapped higher, forcing us to follow our rule. 

My outlook on gold was essentially a play on a possible USD retracement lower, an outlook I might add, that I still have, however I need more technical evidence to support this theory. 

It is important for the investor to undersatnd that there is a direct correlation in the price of commodities and the strength and weakness of the USD.  Typically , as the dollar weakens, we see a strengthening of commodities and commidity based securities.  As the USD weakens, we see the inverse in the commodities market.  This intermarket relationship seems to be playing out in the equity markets as well.  One only has to compare a chart of gold, oil, the S&P/TSX Composite and the Dollar Index to see this relationship at work.  We typically suggest that this observation holds true….until it doesn’t, in other words, we don’t just want to take this relationship for granted, we still need to see clear technical evidence of a change in direction before we jump into positions with a specific directional bias.

With that being said, I wanted to take a look at the USD/CAD chart.  While there is no technical evidence of a reversal, the USD/CAD has been dancing around the par level since the beginning of November.

USD/CAD Daily Chart 

If you believed that the par level should hold as support, acting as a spring board for a possible bounce for the USD against the CAD you could consider buying a USX Call Option.  These options are U.S. Dollar based and  cash settled in Canadian dollars (for more info on the USX click here.)

The simplest way to determine your strike price selection is to multiply the spot market value by 100.  While that is not the exact formula, it is the easiest.  For example, a spot market value of 1.00 (par) would translate to a USX strike price of 100. 

To particpate with a directional bias using options, we typical use an at the money, to slighly in the money option contract…and always give ourselves time for the move to take place…at least 3-4 months.

Until next time

J.