FMX | Connect (Reported 5/23/2011)
The following is a report of Gold Option’s activity in the Over-The- Counter and Exchange traded venues. Information is compiled and summarized below.
Summary
June Gold settled at $1515.40 per troy ounce, a gain of $6.50 for the day. Gold gapped higher overnight and options were bid.
Market Overview:
Over the last week the global marketplace has changed towards showing a deflationary bent. This is usually bearish for gold but we believe that gold will continue to rally and if it doesn’t, it will be the tallest pygmy. There are three items pulling on the market now that are easily identified:
1. Greece is showing signs it may default and is threatening to pull out of the EU if its debt isn’t restructured. This highlights the weakness and potential insolvency of the ECB, even if Greece may be posturing.
2. The U.S. has announced QE2 will come to a definitive end and therefore liquidity will be withdrawn from the U.S. markets.
3. China is combating inflation more aggressively, raising reserve requirements and interest rates.
All three items are deflationary and bearish for risk assets. Commodities and equities are and will continue to get pummeled as this news dominates the market We think gold can also suffer as the dollar strengthens but as long Europe is on the front pages it is likely gold will continue to make new highs against European currencies. In short, gold is competing against the dollar for European safe-haven status.
Options Commentary:
The market opened near 1510 after climbing as high as 1519 in overnight trading. Today was interesting from an options perspective from top to bottom. For the past week the pattern had shown volatility coming in softer due to London-based selling. However, this morning June volatility was 2 percentage points higher than Friday, nearly wiping out the weekend theta. The rest of the board was higher too, in sympathy, up .1 –.2 % across the board.
Once we got underway volatility was stable to slightly firm and risk reversals began to trade for the put. Banks and other dealers bought the August 1450/1600 risk reversal, laying out premium for the put. Their appetite seemed insatiable. A little bit later, the much vaunted October and December 1600 Call buyer came into the market. The call buyer alternated back and forth between the two options for the first half of the day, something we had not observed from him previously. Market makers leaned into his bids hard initially and spread their positions against August calls, sometimes packaged as part of a fence. All three trades persisted through the midday. It must have been nauseating for liquidity providers to sell the October 1600 Call, sell the December 1600 Call and sell the August 1450/1600 fence (selling the put and buying the call), only to see it repeatedly bid for another half dollar of edge. The size and resilience of these orders presents additional risks to liquidity providers. Combined, over 6,000 contracts of the October and December 1600 call traded, a formidable amount and a continuation from last week’s also sizeable purchases. Later, after the risk reversal stopped trading, it got really bizarre.
Not only did the 1600 strike become a bubble within the months it traded, but October, which saw more buying than December today, became a bubble on the term structure.
The last three times these calls were bought volatility did not really comply. Most of the changes were rationalized with skew. Today however, the buyer’s bids remained resting even when the market dropped, in one instance by as much as $2. This changed the whole tone of trading. The resting bid migrated to straddles and even to puts. The December 1525 straddle settled 161 at 1:30 and went out 164/166 at 4:00 p.m. . The October 1525 Straddle settled at128 and the closing market was 131/134. There do not seem to be any sellers left.
When this bubble pops it will probably create a crater but we don’t know when that will happen. One thing to reiterate, options are saying do not be short this market and after seeing today’s activity despite a stronger dollar, we agree. We would like to see this market settle over 1516 or print over 1520 to provide additional confirmation.
Active Options
M 1480P
Q 1450/1600 Risk Reversal
V 1600 C
Z 1600 C
ATM Volatility Curve:
As of 4:00 P.M.
Volatility Smile:
***From NYMEX Settlement
End of Day Straddles
| GC | | | |
| | Future | Bid | Offer |
| M11 | 1515 | 16 | 20 |
| N11 | 1515 | 57 | 61 |
| Q11 | 1515 | 82 | 86 |
| V11 | 1520 | 126 | 130 |
| Z11 | 1520 | 160 | 164 |
| G12 | 1520 | 195 | 199 |
| J12 | 1520 | 224 | 228 |
| M12 | 1525 | 252 | 256 |
As of 4:00 P.M.
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