Trading Example - Gold (GC)

Introduction

My Gold trade is just one of those..- I can't really say why I did it, I had a feeling in my gut, a hunch. Gold is just one of those commodities I have been monirtoring over the years, every day for I don't know how long. Gold was sort of neutral if you zoom out far enough, or maybe slightly down - the chart to the right is a WEEKLY chart. These last two weeks up (last two bars) was just too fast, too explosive, too quick for gold. I thought it was screaming for a correction. I then read a report by one or other Russian guy on Elliot wave theory and he discussed gold and he also felt that Gold went too far and is ready for a correction. Now normally I ignore these wave-theory gurus, just simply because they just shift their theories around as it suits them, they are never wrong.. Anyways, be it as it may, I thought gold was going to correct and this bloke confirmed it for me. And thus I started investigating gold in the Matrix Plus

The Trade

Shown on the left is Gold (March 2015) but on a daily scale, a line chart through the daily closes. You can clearly see that explosive upwards thrust over the last couple of days, followed by the sudden uncertainty right at the top. ("Normal" for gold is that haphazard up-down spiky behaviour you see in the first part of the chart - this is why the last couple of days was "abnormal" for me.) Armed with my little opinion that the Gold market was about to correct downwards, I decided to search in the Options Matrix Plus for what the "big guys" were thinking. Now I cannot go into this in too much detail for fear of giving away some trade secrets - but we collect a lot of data and through the Matrix Plus are able to analyze that data and get a view (1) of where the big guns in the market has positioned themselves for that particular market and (2) of what price level the market is unlikely to reach by expiry date since then the big guns will loose too much money if it does.

I ran this analysis on Gold and I got a very surprising answer - they confirmed for me that Gold has reached too high too fast and is most likely going to correct. I don't have the guts to outright sell gold (or I don't have the account size to eat the loss if I am wrong) but I wanted to see what will happen - thus I decided to paper trade this one as I would have traded it if I had the necessary account size (Paper trade means I don't commit real money, I go through all the same motions as if for real but without actually committing real money into it, thus I demo trade it, which is one of the nice features that the Matrix Plus allows).

Shown on the right is the trade I entered after carefull and detailed analysis in the Matrix Plus. Basically, the Matrix Plus indicated to me that $1,300 on Gold was as high as the big guns would allow Gold to go, thus I should short a Gold Call option at 1300, which with the proximity in price will give me some really nice premium income. However when I analyzed it the Short Call option alone was a bit too risky for me. I wanted to change the risk in the transaction to be more to my liking.
The one thing I learned from the Matrix Plus which I really like is how to manage risk. By also selling a Gold PUT option I can put the market in a strangle-hold. The thing is this - Gold can either go up or it can go down, but it cannot go up and down at the same time. Shorting a call option is daring the market to go up. Shorting a put option is daring the market to go down. Shorting both is daring the market to go up and down which is impossible. Therefore, with shorting both a call and a put we are guaranteed that at least one of these options will expire wothless (meaning we will keep the premium paid). And we can use the profit on this transaction to cover the loss on the other transaction (if required). In other words if the Gold price should go up, the put option will make a profit and the call a loss. But the profit on the put option "buys" us some space to take a loss on the call, and vice versa. This characteristic is what is causing the funnel to open up as in the price chart.
And there you have it:

  • We SELL the GC C1300 (Gold CALL option, 1300 strike price), 32 days left for expiry, for a premium of $3,063 - this is nice!
  • We also SELL the GC P1250 (Gold PUT option, at 1250 strike price) for $1,073 - price is much further away from 1250 and therefore the risk is much lower and this the reason for the much lower premium
  • Total income from these two transactions = $4,136 - this premium is paid into our trading accounts and is non-refundable - that is right, someone somewhere is PAYING US to enter this position, we are being paid to trade!
  • If the price of Gold enters the funnel between the two thick yellow lines, and stay in that funnel, we will be making money! (What is the chance of this happening? My thinking is the odds are in my favour on this trade!)
  • Should the price of Gold stay in the funnel by expiry date - the end of the graph - then we keep all the money - yes all $4,136 of it!
  • Should the price of Gold go outside of the funnel, we will start losing money, the feint yellow lines show where we will be taking a $500 loss on this transaction!

And this is what happened to Gold! Nine days into the trade and we can see a clear downtrend starting to form. That last day, I wanted it to go up - if it did go up it would have signalled to me that Gold is likely entering a flat spot, a trading range, an area of uncertainty and it will probably then stay there to the end. But the downwards move indicated to me that the highest probability is for Gold to now take out the previous low point on the graph, in which case the downtrend will be intact and my profitability in the trade will be in danger. Thus I decided to exit.

  • I bought back the Gold Call option for a pemium of $739 (nice profit on this one)
  • I bought back the Gold Put option for a premium of $1,441 (made a bit of a loss on this one)
  • Net profit on transaction = $4,136 - $739 - $1,441 - $11 (commission to my Broker, $2.75 per transaction) = $1,945
  • Margin required to take this transaction = $20,280. Thus 9.6% return on investment is just 2 weeks!
  • For interest, this is what happened to Gold for the rest of the time. For the next six days the position was still profitable, however you could distinguish a very clear downtrend and you had ample time to get out of the position with a profit. Thereafter it went into the negtive.

    What makes this method of trading so attractive is the amount of time you have to make a decision. You do not have to sit in front of your computer all the time, waiting to split-second time a transaction, or for this moving average to cross that moving average in combination with this or that momentum indicator and... It is a much simpler approach of determining the likely direction that the market is to take and then determining a strategy to trade that market. You do all your analysis off-line, you test it with different trading strategies, you play devil's advocate, change the prices up or down, see what the effect will be, play with different positions - all in the afternoon or whenever you have time. Once you have certainty about how you will handle different situations you enter the position and wait.. From then on all you need to do is monitor the trade, once a day when you get data and decide when it is time to get out. Even if you are wrong and you get out a day later you're still not taking a loss, you just take less of a profit! It is a relaxed form of trading. It is the form of trading that you can do while doing your regular job, to slowly build out your trading account until you are able to retire. It is also the ideal retirement income!