Limiting Risk on the Syria Trade
Syria is back in the spotlight, again, as potentially the hottest of the global hot spots. The focus has been on the country’s conflict for some time. But, just weeks ago, President Trump was insisting he would wind down the presence of the U.S. military in the country.
Now, the President is tweeting, “Russia vows to shoot down any and all missiles fired at Syria. Get ready Russia, because they will be coming, nice and new and ‘smart!’ You shouldn’t be partners with a Gas Killing Animal who kills his people and enjoys it!”
Oil prices are responding to the news by rallying. The chart of SPDR Gold Trust (NYSE: GLD) below shows the recent price action in GLD along with its historical seasonal trend. Gold is due for a bottom in that trend, and the news could push prices as well.
Also in the chart, gold prices broke out to new highs. This is a bullish. In fact, some technical analysts say that “there is nothing as bullish as new highs” since that is the confirmation of an up trend in the prices. Technicals combine with news and seasonals to highlight the opportunity in gold.
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Trading the Yellow Metal
Gold, or the ETF GLD, could be bought directly. However, those instruments are taxed as collectibles, different than stocks or other ETFs. That makes the trade in GLD a little more complex for individuals in taxable accounts. Traders could use options to avoid these problems.
However, traders could also use options strategies with gold miners to boost the potential gains. An advantage of miners is that they provide leverage exposure to the metal. If prices of gold rise, the profits of miners should rise even more since price increases above the cost of production flow straight to a mining company’s bottom line.
One of the most active gold mining stocks is Kirkland Lake Gold Ltd. (NYSE: KL). This stock has less than one year of trading history.
KL, like gold, is breaking out to new highs. The stock is more volatile than gold itself which means gains in KL should accrue quicker than gains in gold. This is advantageous to short term traders seeking to make trades quickly to compound capital in an accelerated manner.
A Trade for Short Term Bulls
As with the ownership of any stock, buying KL could require a significant amount of capital and exposes the investor to standard risks of owning a stock.
To reduce the risks of a trade, an investor could purchase a call option. This allows them to benefit from upside moves in the stock while limiting risk to the amount paid for the options. However, buying a call option can also require a significant amount of capital and includes the risk of a 100% loss.
Whenever an option is bought, the maximum risk is always equal to 100% of the amount of spent to purchase the option. Since options cost significantly less than a stock, the risk in dollar terms will usually be relatively small to own an option.
To further limit the risks of the trade, an investor could use a bull call spread. This strategy consists of buying one call option and selling another at a higher strike price to help pay for the cost of buying the first call. The spread strategy always reduces the risk of an options trade.
This strategy is designed to profit from a gain in the underlying stock’s price but has the benefit of avoiding the large up-front capital outlay and downside risk of outright stock ownership. The potential risks and rewards of this strategy are summarized in the chart below.
Source: The Options Industry Council
Both the potential profit and loss for the bull call spread are limited. The maximum loss is equal to the net premium paid when the trade is opened. The maximum profit is limited to the difference between the strike prices, less the debit paid to put on the position.
This strategy could be especially appealing with high prices stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.
A Specific Trade for KL
For KL, the May 18 options allow a trader to gain exposure to the stock
An May 18 $15 call option can be bought for about $2.00 and the May 18 $17.50 call could be sold for about $0.30. This trade would cost $1.70 to open, or $170 since each contract covers 100 shares of stock.
The amount paid to enter the trade is the largest possible loss on the trade. This is generally true whenever a trader is creating a debit to enter an options trade. “Creating a debit” means there is a cost to enter the trade. You could create a debit by simply buying puts or calls to open a directional trade.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $170.
The maximum gain on the trade is equal to the difference in exercise prices less the amount of the premium paid to open the trade.
For this trade in KL the maximum gain is $0.80 ($17.50 – $15 = $2.50; $2.50 – $1.70 = $0.80). This represents $80 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $170 to open this trade.
That is a potential gain of about 47% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.
In this trade, options provide income and defined risk. These are the type of strategies that are explained and used in TradingTips.com’s Extreme Profits Calendar service. This service uses seasonals as one indicator in its trade selection process. To learn more about how options can be used to meet your goals, click here for details on Extreme Profits Calendar.