Gold Options activity took a turn towards the bizarre late Friday. Between the hours of 2pm and 4pm Eastern, put buyers came out of the woodwork. We are almost certain that Doug Kass's interview on Fast Money was the sole cause of this activity. He was interviewed at 5pm. The put buying frenzy came in a full 2 hours beforehand on a Friday.
Mr. Kass runs Seabreeze Partners Mgt. and is known for timely accurate market calls in the past. Here is what he said about Gold for 2011. "Gold will drop $250.00 in a span of four weeks" The reasons for his bear stance are simply that rising interest rates will cause money to flow out of the metal as a hedge and into higher returning assets. His reasons are logical and represent a growing contingency of managers that think many economies are doing better. China, Brazil and others are raising rates to battle inflation. This would reduce demand form these countries for Gold as a hedge. We don't necessarily agree, thinking that the U.S. cannot follow their lead, the result of which just means a weaker dollar. Hence gold remains firm in dollar terms. But his track record speaks for itself.
He closed by stating "Gold will briefly touch $1050.00/ OZ. and should finish the year $150 lower than where it is today.
What we are focusing on is the option activity that occurred before his interview.
Pre Interview Put Party
The Comex floor day ends at 1:30. Friday's activity was largely uneventful during floor hours. There were some put buyers scattered in the back months and some call sellers in the mid months. Other than that trading was dominated by dealers and market makers squaring up their February positions as we head towards expiration this week.
But post floor close activity became pointed and focused on one thing, mid month put buying. Between 3,000 and 6,000 puts traded between 1:30 and 4:15 (that is GLD equiv of 30 to 60k volume). It started at the April 1000 strike, a 4 tick option. but the buying spread virally from there to June, then Dec, back to August and finally to April and March strikes. Back month put premiums expanded by 2 to 5 percent, while shorter dated options like the April 1250 strike went from a 10.50 offer to an 11.90 bid, a premium change of 10%. Yet the market was $2.00 higher when the bids came in.
Normally post Comex close, Globex order flow is driven by GLD ETF business. Retail and equity side business usually dictates volatility for this part of the day. But that wasn't the case Friday. The business came in on the commodity side first this time, and it most definitely was not retail in size or sophistication. Fast Money Fans were not the buyers.
We decided to model the market's pre to post activity to get a handle on just how big the changes in put values were.
- March 1200 From 1.40 offer to 2.00 bid
- April 1000 From .40 offer to .60 bid
- April 1100 From 1.40 offer to 2.10 bid
- April 1250 From 10.40 offer to 1190 bid
- June 1100 From 5.00 offer to 6.20 bid
- June 1200 From 22.50 offer to 24.50 bid
- Oct 1150 From 16.00 offer to 18.00 bid
- August 1280 From 46 offer to 48 bid
- Dec 1000 From 10.50 offer to 12.70 bid
Calls Were Not Invited
This only tells one side of the story. It's obvious puts were bid. What isn't is that calls were offered, because so few traded. What we really had was a large skew change with no market movement. Vix followers take note: ViX predicts nothing. ViX changes are reactionary to market movement, not predictive. But changes in skew, while not predictors of direction do tell you what will happen to the ViX if the market moves. In summary: A move lower will cause a pop in the Gold ViX. while a move higher, will almost certainly result in a sell off in volatility. Take a look at this smile, pre to post activity. it tells a simple tale: People are hedging long positions or are outright bearish. Any move lower from here will be emotional. Fear if you are long the market, and greed if you are short. Take your pick, but it won't be pretty if you are short options and Kass is right.
April Options Smile
Key: Orange represents closing market values, Blue represents post market values
So where did this buying come from? We don't know. Fund managers have been talking their positions for generations. If a guy is on the cover of Barron's is telling you to buy IBM, it ain't because he's short it. Maybe he Kass was buying pre his interview. Maybe it was some friends who share his view. He twittered his opinion at 2:00 PM. Maybe it was a coincidence. Regardless, people are saying Gold will go down, and are putting money on it.
Gold Bull Despair
Most of our readers are bullish Gold. Here is our advice to those people. If you are bullish on Gold and trade options, ( Disclaimer: and have money you can afford to lose) buy hedged puts or hedged put spreads. In a rally, the hedge will offset any decrease in volatility, while naked long calls will be offered every step of the way by trapped longs. And if you buy hedged puts and we do sell off, you wont be sorry. Options exhibit Giffen Good qualities at times, and that is beginning to happen now. If the market has a strong day higher, do not expect put bids to go away, expect call offers to trickle in. That would potentially change if we breached and stayed above the 100 Day Moving Average which comes in around 1351.
Final note, keep an eye on silver spreads. They continue to come in, indicating a squeeze may be on the table despite the paper sell-off.