gold option commentary_october_2010
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October 2010
Steve Ellis
Consultant to Baker Steel Capital Managers LLP
Gold Options Commentary
Gold Options Chartbook and Commentary
Option Strategies to Maximise Risk Adjusted Returns
October 2010 2
Steve Ellis
Consultant to Baker Steel Capital Managers LLP Gold Options Commentary
Gold Price Volatility (Realised Vs Implied)
Key Takeaway: Volatility is low and options have become inexpensive
October 2010 3
Steve Ellis
Consultant to Baker Steel Capital Managers LLP Gold Options Commentary
Implied Gold Volatility (Vs G10 Currency Volatility)
Key Takeaway: Gold options cheap compared to other vol markets based on historical levels
October 2010 4
Steve Ellis
Consultant to Baker Steel Capital Managers LLP Gold Options Commentary
Term Structure of Implied Vol’s – Now versus 1 month prior
Key Takeaway: Short dated options are substantially better value than long dated
1w
2w
3w
1M
2M
3M
4M
6M
9M
1Y
18M
2Y
3Y
October 2010 5
Steve Ellis
Consultant to Baker Steel Capital Managers LLP Gold Options Commentary
Skew of Implied Vol’s – Implied Volatility for Equivalent Calls Vs Puts
Key Takeaway: Investors over-confident particularly in “longer term”
1w
2w 3w
1M
2M
3M
4M
6M
9M
1Y
18M
2Y
3Y
October 2010 6
Steve Ellis
Consultant to Baker Steel Capital Managers LLP Gold Options Commentary
Rough Sketch of Favoured Strategy
Key Takeaway: Buy short dated Puts; Sell longer dated Calls
5P
10P
15P
20P
25P
30P
35P
40P
45P
atm 45C
40C
35C
30C
25C
20C
15C
10C
5C
October 2010 7
Steve Ellis
Consultant to Baker Steel Capital Managers LLP Gold Options Commentary
Recommended Hedge Strategy Section
Key Assumptions:
Base Portfolio is Long 100% Junior Gold Equities
Hedging Risk Budget = 5% p.a.
Max Notional on Aggregate Short Options = 10%
Gold and Gold Junior Equities experience distinct volatility but they correlate directionally at +1.0
Upside/Downside (U/D) Target is 2:1
Gold Juniors 1 month ATM Implied Vol. 33% (9.5% per month)
Gold Prices 1 month ATM Implied Vol. 18% (5.2% per month)
October 2010 8
Steve Ellis
Consultant to Baker Steel Capital Managers LLP Gold Options Commentary
Recommended Hedge Strategy Section
Scenario 1: Base Juniors Portfolio Up and Down 2 Standard Deviations Best Upside/Downside = 1.1 (Gold Juniors)
Hedge Notional (Delta Adjusted) at Best U/D ratio: N/A
Cost of Best U/D ratio: N/A
October 2010 9
Steve Ellis
Consultant to Baker Steel Capital Managers LLP Gold Options Commentary
Recommended Hedge Strategy Section
Scenario 2: ATM, 95% Strike and 90% Strike Gold Puts (6 months) Best Upside/Downside = 1.19:1 (90% 6m Puts)
Hedge Notional (Delta Adjusted) at Best U/D ratio: -61%
Cost of Best U/D ratio: 2% (4% p.a.) out of 5% budget thus max hedgeable = 125%
October 2010 10
Steve Ellis
Consultant to Baker Steel Capital Managers LLP Gold Options Commentary
Recommended Hedge Strategy Section
Scenario 3: ATM, 95% Strike and 90% Strike Gold Puts (3 months) Best Upside/Downside = 1.50:1 (90% 3m Puts)
Hedge Notional (Delta Adjusted) at Best U/D ratio: -122%
Cost of Best U/D ratio: 0.5% (2% p.a.) out of 5% budget thus max hedgeable = 250%
October 2010 11
Steve Ellis
Consultant to Baker Steel Capital Managers LLP Gold Options Commentary
Recommended Hedge Strategy Section
Scenario 4: 90% 3m Puts + (Sell 110% 12m Calls to buy 95% 1m Puts ) Best Upside/Downside = 1.80:1 (90% 3m Puts) + (Sell 110% 12m Calls) to buy (12 consecutive 95% 1m Puts)
Hedge Notional (Delta Adjusted) at Best U/D ratio: -155%
Cost of Best U/D ratio: 0.5% (2% p.a.) thus max hedgeable = 250% (90% Puts) + 33% (95% 1m Puts)
RBSGF 1 Month Returns: +/- 0.5,1.0,1.5,2.0 Std Deviations
-20%
-15%
-10%
-5%
0%
5%
10%
15%
20%
-20% -15% -10% -5% 0% 5% 10% 15% 20%
Junior Gold Miners
Unhedged Prefered Portfolio
-2.0 -1.0-1.5 -0.5
October 2010 12
Steve Ellis
Consultant to Baker Steel Capital Managers LLP Gold Options Commentary
Conclusion
Scenario 4 has the best Upside/Downside ratio (1.80:1) of the strategies examined.
Buy purchasing short dated puts and selling longer dated calls in takes maximum advantage of both Term Structure (page 4) and Skew (Page 5)
Purchasing the (90% 3m Puts) protects against a sustained fall in gold prices over a decent period of time
By selling (Sell 110% 12m Calls) to buy (12 consecutive 95% 1m Puts) additional “gap risk” is provided for at all times. Each month 33% notional protection can be secured (below 95%) in return for giving up 10% upside (beyond the 110% strike)
With a combined Hedge Notional (Delta Adjusted) of -155% at 2 standard deviations below today’s levels the protection offers enough exposure to cope with Gold Junior’s higher Beta versus Gold Prices
Ceteris Paribus (for option pricing, term structure and skew) the structures could simply be repeated at expiry
Any significant inflows or redemptions could be added/subtracted on an as needs basis
October 2010 13
Steve Ellis
Consultant to Baker Steel Capital Managers LLP Gold Options Commentary
IMPORTANT
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