Doug Kass Invented the $1600 Call in Gold Options
This morning a member of the FMX|Connect community alerted us to an
article written by Doug Kass about Gold options; specifically the recent
large purchase orders for options in the $1600 strike expiring August
through December 2011. We think we know a little something about options
and would like to dissect Mr. Kass’ comments for accuracy and
authenticity. Specifically, his work seems loosely and sloppily based on
our own. Our FMX | Connect Gold Options Recap is circulated among hedge
fund managers, commodity option marketmakers, and retail investors. It
finds its way onto Kitco’s home page
nearly every day. Moreover, until today, no one else has said anything
about these purchases accept us. We just find it hard to believe that
the kernel for his article was somewhere in his head.
one has a monopoly on ideas, those that “think” of them second usually
cite the inspiration or source for the (in this case) sloppy,
sensational analysis. Even more grating, his inaccurate work made its
way onto Art Cashin’s Daily report. We are huge fans of Mr.Cashin here,
and would like to say this up front to him: If you are looking for Commodity Options data, analytics, research, or color, come to us. We are best-of-breed in the category.
we created FMX| Connect part of our mission was to avoid a
sensationalist bent, and stick to the facts. Unfortunately, this is not a
recipe for a quick buck or for investors throwing money at us to manage
because of our accurate directional calls.
We are building a firm respected for research and analytics with as
little bias as possible. It was in this vein we purchased a stake in Cameron Hanover,
Peter Beutel’s firm, well known for his objective fundamental energy
analysis. We state this because it is our intellectual capital that is
our franchise. So when a person or firm uses it incorrectly and without
citation, we must defend ourselves. But before we do, here is Mr. Kass’
note this morning in its entirety, after which we will do an autopsy.
Who Is Goldfinger?
5/24/2011 7:24 AM EDT
Pretty girl, beware of his heart of gold
This heart is cold
He loves only gold
He loves gold
He loves only gold
-- "Goldfinger," composed by John Barry and with lyrics by Leslie Bricusse and Anthony Newley, popularized by Shirley Bassey
is Goldfinger? Over the course of the past few months, one large buyer
has accumulated approximately 50,000 gold call option contracts -- most
of the calls are strikes between $1,600 and $1,800 an ounce and for
expirations between August and December. In total, as much as $50
million in call premium has been paid out by the purchaser.
the gold futures market is roughly 10x to 15x the size of the gold
options market, this is a huge bet in absolute dollars relative to the
liquidity of the market.
Considering that the calls are well
out-of-the-money (gold, on a futures basis, today trades at $1,512), the
call option is all premium and, as such, is a decaying asset. So, given
the size of the purchase, the buyer is not likely an individual hedge
fund -- more likely, it is a central bank or a sovereign fund.
is interesting to note that all of the buyer's options mature after
QE2, so the buyer might believe, for example, that the institution of
QE3 holds a greater probability to be implemented than the consensus is
The buyer is clearly betting on a large run-up in the price of gold during the summer and fall months.
all this leverage in the hands of one owner, a sharp price appreciation
in the price of gold could cause the shorts (on the other side of the
call option trade) to continuously buy futures and further contribute to
a rising gold price in order to maintain a flat delta. One thing is
certain, Goldfinger loves only gold.
Douglas A. Kass
Seabreeze Partners Management Inc.
Post Mortem of Doug’s Discovery
We’ll start with the lyrics:
Pretty girl, beware of his heart of gold
This heart is cold
He loves only gold
He loves gold
He loves only gold
-- "Goldfinger," composed by John Barry and with lyrics by Leslie Bricusse and Anthony Newley, popularized by Shirley Bassey “
In this case he has the good sense to cite the authors of the lyrics. Clearly ASCAP has better lawyers than we do.
Who is Goldfinger? Over the course of the past few months, one large buyer has accumulated approximately 50,000 gold call option contracts -- most of the calls are strikes between $1,600 and $1,800
an ounce and for expirations between August and December. In total, as
much as $50 million in call premium has been paid out by the purchaser.
ONE LARGE BUYER?
giving away trade secrets or getting too option wonky, we’ll just say a
few things. How does Mr. Kass know it is a single buyer? This is a
dangerous and sensationalist thing to say as if it were fact. It is a
mistake to assume that unless you have empirical evidence or at least do
some work to back up your statement. For our own part we are pretty
sure it is a single buyer. How did we come to this conclusion? We did
the math. We studied and saw the orders as they hit the markets. We
noted how all other gold options behaved in their respective venues. We
looked at how the order was placed, the volumes, the timing, the times
of day, and the total volumes traded on the day. In short, we read the
tape and gathered intel.. And still we are not 100% sure it is a single
buyer. It may be a single executor for multiple buyers. How did Mr. Kass
come to this conclusion, we don’t know. But like other things he says,
we can cover them all with this quote, “You have eyes, plagiarize!”- Ed
$1600 and $1800 STRIKES?
This is a
complete falsehood, and a product of sloppy research. As a caveat, we
ourselves admit that the buyer(s) could have bought different strikes,
but we operate on a Bayesian approach as part of our analysis. All the
order flow that came in with the same execution style was at the 1600
strike. That is it. Certain orders walked and quacked like ducks, and
they all were at the 1600 strike. Any other option that traded was on
the back of the 1600 calls trading, as arbitrageurs attempted to spread
their risk. Whether it was Comex, Globex, OTC Clearport, or GLD we
gathered intel from all the markets in our analysis. Whether it be
straddles, higher strike calls, or calls at different expirys, they were
all in reaction to the single origin order in the market, the 1600
Buying of other calls prior to April was from a different
fund, one based in Europe and those were in outright and call spread
form. They also were filled and billed at a single price per order, not
averaged in like the 1600 call buyer did 4 to 11 lots at a time. They
were also executed on the floor, not Globex like the 1600s were. That
other fund alone spent $50MM separately from the August though Dec 1600
Using Mr. Kass’ exacting timeline of a “few months”
we are quite confident that multiple funds were buyers. Using OUR time
line of April 21st thru May 23rd we’d lay odds it was a single buyer and that it was just the 1600 call. So, Kass is wrong on several counts.
certain macro funds operate with a price target. We believe this one
operates in such a way. Funds that think “target”, pick a strike that
reflects that target. They do this because they are already massively
long futures and would like to SELL the futures at their target, but
retain upside exposure for their fund as they take profits. They don’t
buy vertical combos, they buy the same strike thru time. How do we know
this? We don’t. But we deal in probabilities, not certainty. Experience
and odds say we are correct here.
gold futures market is roughly 10x to 15x the size of the gold options
market, this is a huge bet in absolute dollars relative to the liquidity
of the market.”
We’ll give him a pass here, but
something should be added. Options are typically the tool of the
undercapitalized. Meaning, you want limited risk and can’t afford to
deal with a margin call. So you buy options instead of futures. In this
case though, we are pretty sure the buyer(s) view the options positions
as loose change. We are pretty sure their total gold exposure dwarfs the
options exposure by multiples. Probably 10 to 15x worth. And here is
the interesting thing. Despite the magnitude of the purchases,
volatility has hardly budged. So clearly, the market is pretty liquid to
absorb that kind of buying and not have a total melt up as Mr. Kass
What should be considered if you are a serious
journalist or commodity analyst is the fact that the buyer got filled.
There was plenty of sell side liquidity coming out of London during his
buying spree. This is a BEARISH factor. Remember for every buyer there
is a seller, and all that matters is who the stronger hand is. The more
“Considering that the calls are
well out-of-the-money (gold, on a futures basis, today trades at
$1,512), the call option is all premium and, as such, is a decaying
asset. So, given the size of the purchase, the buyer is not likely an
individual hedge fund -- more likely, it is a central bank or a sovereign fund”
CENTRAL BANK OR SOVEREIGN FUND?
cannot say he is wrong here but we doubt his analysis is anything more
than conjecture. Here is our own. As stated above, this is loose change
for a fund that has billions under management. Second, if this were a
central bank the information leakage would be horrific, as every Bullion
bank on the street would be front running this order. Central banks
have been saps to Bullion dealers for years. And while we know they have
become savvier in recent years, we doubt they have the sophistication
or permissibility to have options on their balance sheets. Remember,
Central Banks are the guys who for years loaned their Gold at basically
zero percent to bullion dealers who then took that Gold, shorted it and
proceeded to place the money in other assets. And if Gold went up, they
borrowed some more. Central bankers aren’t that bright tactically.
to it being a sovereign fund, maybe so. But how about a little analysis
to back up the opinion? We can just as easily say that, but none of our
own evidence points that way. Our evidence points to a single fund, but
we admit we could be wrong. But if it is a sovereign fund or a central
bank, it is not because of the money spent. So simply saying “it’s a lot
of money, therefore it’s a Sovereign Fund” is a bet we’d take the
opposite side on.
“It is interesting to note
that all of the buyer's options mature after QE2, so the buyer might
believe, for example, that the institution of QE3 holds a greater
probability to be implemented than the consensus is currently
Nice concept. But this is
what we call “ocular regression”, aka making the data fit the story you
are selling. It’s how we tease each other when one of us is
rationalizing his opinion at FMX. The buyer might also believe we are
about to be invaded by aliens that eat gold and excrete dollars. Who can
tell? But it is a good story. Ours works too, we have a call into the
But what if the fund, central bank, sovereign
fund or gold eating aliens were long a boatload of futures, GLD and
physical for the last two years? Does that diminish the timing of this
as a bet on QE3? Yes it does. But let’s not let the facts get in the way
of a good story, Doug. We happen to think the buyer is just betting on
inflation in general and much of his portfolio is one large expression
of this concept. That doesn’t sell papers, but it is more likely the
And if true analysis is done on the first purchase (the
August 1600 call) the market ran to 1570 within a couple weeks after the
order was filled. This was while George Soros was reportedly selling
his Gold. So the buyer may not be bullish at all. He may actually be
EXITING the market while buying calls to misdirect and create his own
exit strategy. It’s just bad practice to lead investors to think that
because options are being bought, the buyer is bullish. There are so
many ways an option can be used to mislead the broader market to simply
say “this is bullish”.
And for the record, we don’t think Soros
is the buyer. He generally does not use options, citing that the entry
and exit vig create high implicit fees. Options liquidity providers are
like bookies to him. He prefers to buy futures on margin. But we deal in
probabilities, not certainties.
‘The buyer is clearly betting on a large run-up in the price of gold during the summer and fall months.”
Clearly…….. See above for comment on this. To add some historical context.
upon a time there was a firm that traded its own account and also
handled orders for VERY large hedge funds. Sometimes they were given
large orders to buy futures for a client: 10,000 to 50,000 lot orders.
As they were patiently buying futures for their client, they would buy
calls for their own account with the client’s blessing. When the futures
order was almost filled, their patience in accumulating for the client
morphed into aggressive buying at the market (or worse). This is an
example of beating the VWAP. And when the futures order was filled the
market would magically be trading near the strike they bought calls on.
But the market could go no higher. For in this story, the Broker who
also had accumulated a large call position would sell as many futures as
he could at this level, turning his calls into puts. The market would
often collapse afterwards, from the weight of the Broker selling and the
lack of buying that same Broker was doing prior.
had done 3 things. First he successfully beat the VWAP for his client.
Second, he suckered all the momentum chasing funds into getting long.
Finally he top ticked the market and started selling as soon as his buy
order was filled. So when you consider that Gold ran up to 1570 just
after the purchase of the August 1600 calls in April ( the first
execution by our Alien Sovereign Fund Bank or ASFB) but stopped dead in
its tracks only to trade down to 1462.50 soon thereafter, understand
nothing is “clear” when it comes to what a call buyer wants the market
With all this leverage in the hands of one owner, a sharp price appreciation in the price of gold could
cause the shorts (on the other side of the call option trade) to
continuously buy futures and further contribute to a rising gold price
in order to maintain a flat delta.
it could cause shorts to hedge negative gamma. But it is our opinion
that risk isn’t something to worry about until the last week of
expiration. Expiration week is historically the time when options can
temporarily assert undue influence on a market. And since this is spread
over multiple expirations, only one month at a time will be at issue.
So we view this as not a big thing to talk about. If you are going to
talk about it, balance the discussion with the concept of PIN risk. It
is equally likely that if we are near the 1600 strike at expiration,
that the market flat-lines there. It all depends on who the stronger
hand is. And historically, if banks are the short to this buyer, then
bet on the banks with their ZIRP financed mark-to-myth balance sheets.
And negative gamma works both ways. Option shorts lose if we go down
too. It’s not that simple to imply we are going up because the shorts
will make it happen.
The FMX| Connect Gold Options Research
be fair, everything said by Mr. Kass could be true. Our autopsy above
was only to show that this type of information is incomplete, misleading
and irresponsible especially if you handle investor’s money. This is
typical of people who have inherent conflicts of interest in finance.
The work was simply not done on this analysis. And while we cannot prove
it, we’d be willing to bet that the idea for the report was in the very
least gleaned from one of FMX | Connect’s many reports on the topic.
Take your pick:
August 1600 call buyer
October and December 1600 Call buyer
you use our intellectual capital without proper credit or citation, you
will be called out on it as the hack and huckster you are. We can’t
prove it, but we can ask, what was the initial source of the idea Mr.
And if you are a professional in search of objective MTM
services, market intelligence, data, and analysis for Energy, Metals,
and Grains, consider Cameron Hanover and FMX |Connect as opposed to paid
contributors who can sell it but can’t build it. We watch the markets
we report about all day, and understand derivatives like no other firm
in Commodities. Our content is our product.
Journalistic Integrity and Fiduciary Responsibility
Ironically we cited Mr. Kass when he made a bearish statement on Gold some months ago.
We actually gave him credit for influencing the market in the short
term as some large put buying came into Gold right before his comments.
We thought, “Wow, this guy must have a lot of influence.” In retrospect,
this is scary. People listen to this guy, and he may be front running
his own statements.
Doug Kass is a frequent guest on the Fast
Money show on CNBC, where he makes predictions and is given the respect
accorded to kings. First off, Fast Money is a joke, and CNBC should be
ashamed as to what it has become. He is also a frequent contributor to
The Street.com; a Jim “Bear is safe, I promise” Cramer product.
We say product because that is what these guys are: shills and
hucksters, selling hot ideas to get people to buy their books, invest in
their funds or click their ads.
These are just examples of
organizations and people who have inverted the capitalistic model. They
took: “Provide a service and if you are good, make some money off of
it.” And changed it to, “Make some money and if we are providing a
service then more power to us.”
(As we write this, Fast Money has just presented Doug Kass’ “discovery” on the options markets. Too funny)
Here are some questions we’d like the Fast Money people to ask their paid contributor
· Where did he get the idea- what was the piece of data that focused his attention on the volumes?
· Is there any research to confirm his findings?
· Why are they being bought- is he bullish or hedging a massive bear position
· Profile the buyer- what type of entity is he, who is he, what is his motivation
· Exit strategy- will he sell, hedge or just let go out worthless if he is wrong
· Complementary trades- is he selling puts, buying futures, selling futures?
· How is he executing them- OTC, Globex, Comex
· What is his Modus Operandi- does he buy in size or average down.
Who Really is the Buyer?
our own analysis, we have narrowed down the list of potential buyers to
4 funds with 3 potential bullion banks executing for them. The buyer
bought futures as well, and is adding to a substantial position. We
truly don’t care who it is. We care more about how the market reacts as
risk managers and market advisors.
We think the buyer is done,
and if he does come back it will be for a February option. We do not
think he will sell these out whether he is right or wrong based on
previous trades. We also do not think that he will hedge if the market
rallies. But our analysis is dynamic and is subject to new information
all the time. This is just a snapshot of where we are now.
the buyer doesn’t even care that much about these options. He has a
much bigger position in other assets. But options are our business, so
we pay attention.
closing, we’d like to list for your viewing pleasure some of Doug Kass’
most recent predictions for the markets. And remember these predictions
before you go out buying GLD because some guy says gold is going up.
Know the risk.
Dec, 2010: Gold will Fall in 2011
Feb, 2011: John Paulson is Neutral on gold
Late 2009: The Dow will fall