HardAssetsInvestor

Written by Brad Zigler  |

July 07, 2010

SGOL Offers (Limited) Options For Investors

Details

So far, the newly created option market for the ETFS Physical Swiss Gold Shares (NYSE Arca: SGOL) offers very few, um, options for users.

Option trading was launched Tuesday on SGOL and its sister trust, the ETFS Physical Silver Shares (NYSE Arca: SIVR), with a bare handful of strike prices. It's a pretty small handful. Take the August contracts for silver trust shares, for example. One—and just one—strike price is quoted, and that's for a call struck more than $2.00 out of the money.

There are more choices in the mart for gold trust options, but not many. With the trust shares trading at the $119 level, strikes for seven August contracts ranged from $121 to $127, making every call choice out of the money and every put in the money.

Certainly, it's early, but market makers advertise their willingness to trade through quotes. No quote? No order flow.

Let's look at those gold options again. Suppose I'm latently bullish on gold, but believe further selling is likely before support is found. Selling puts is a nifty—and possibly pocket-filling—way to end up long gold trust shares on a short-lived sell-off.

Puts grant their owners the right, but not the obligation, to sell the underlying asset at the option's strike price. The seller of the contract undertakes the contingent obligation to be the asset's buyer if and when the put is exercised. If the put buyer never exercises the option, the contract expires and the seller keeps the premium as profit.

If you sell puts, you bank on the underlying shares to decline to a level far enough below the strike price to entice its owner to exercise the contract. Then you hope the share price trajectory reverses to head north. A flat or rising market—one that leaves the puts out of the money—won't tempt the buyer to exercise.

The trouble with SGOL's option market is this: When one sells puts as a means to acquire assets under their current market price, strike prices must be offered under the current market price. There aren't any out-of-the-money puts quoted.

That alone—aside from the market's present illiquidity—will drive potential business over to GLD's (the SPDR Gold Shares Trust) option market makers.

At last look, GLD shares were changing hands at the $117 level. GLD put options are quoted on 58 strikes ranging between $151 and $69.

Suppose you felt GLD shares were likely to retrace half of their February-June rally, say down to the $113 level, before reversing. August $113 puts could be sold for $1.77 per share (since an option contract covers 100 shares, the total premium is $177).

GLD shares, in all likelihood, would need to trade below the strike price to attract an exercise, so if you're confident that $113 will hold as support, you may instead wish to sell short the $114 put offered at $2.08.

Selling out-of-the-money puts on an asset you want to own is, in essence, equivalent to placing a buy limit order under the current market. With the option trade, however, you get paid for placing the order. And you get to keep the cash whether you purchase the shares or not. At exercise of the $114 put, your effective purchase price would be less than $112 per share (the $114 strike price less the $2.08 premium, or $111.92). And if GLD doesn't decline? You've got $208 in your pocket.

The put-as-limit-order trade is possible in the GLD option marketplace, but not SGOL's. Perhaps this will serve as a wake-up call to SGOL's sponsor and market makers. Add some strikes!