How to Buy Gold… At the Price You Want and Get Paid For It
by Lee Lowell, Advisory Panelist
Tuesday, September 29, 2009: Issue #1104
So what exactly is the best way to grab profits from the important and often explosive world of commodities?
In my column last week, I showed you some of the spectacular moves that the four most actively traded commodities (oil, natural gas, gold and silver) have made over the past couple of years.
And when you see the wide trading ranges, it also gives you an idea of just how lucrative they can be.
But you don’t need to be an expert to take advantage. You just need to know how to play them intelligently, using strategies that minimize your risk and maximize your profit potential.
Easier said than done, right? Nope. That’s what I’m here for. And today, I’m going to show you how to add commodities to your portfolio in a much easier way than through futures or futures options, and a much better way than by just buying commodity stocks outright.
Two Reasons Why You Should Use A Put Option Strategy
Perhaps the best way to play commodities is through the options market.
But if you think “commodities and options” in the same sentence sounds scary, think again! Let me explain to you how you can do so, using one of my favorite strategies when you want to take a bullish stance.
It’s called “put-option selling.”
Let’s run through the basics first…
In the options market, a buyer of put options has a bearish stance on the underlying asset (be it the overall market, or stock). Alternatively, a seller of put options is adopting a neutral or bullish stance on the underlying asset.
And the flexibility of the options market allows you to sell options as an opening transaction instead of having to buy them.
In this case, we’re the put-option sellers – a technique that has a superb double benefit.
- You receive income upfront – yours to keep, no matter what happens with the rest of the trade.
- You have a chance to buy the underlying asset at the price you want – and at a large discount to the current price.
Here’s how it works…
Create Your Own “Discount Store”
Whenever you sell an option contract (either a call or put option), the option buyer pays you for it. This money is yours to keep and it gets immediately placed into your trading account.
When you sell a put option contract in particular, not only do you get the immediate cash payment, but you are also giving yourself the chance to buy the underlying asset at the (strike) price you select.
In short, someone is paying you cash so that you can buy the asset at the price you want. How great is that?
Let’s run through a hypothetical example – using the commodities market – to show how put-option selling is as simple as it seems…
Say you’re bullish on a gold stock, but the price has run up too much for your liking. You want to wait for a pullback to the 200-day moving average area before you buy.
Now that commodities exchange traded funds are an extremely popular and easy way to trade commodities, you decide that you’re going to use the SPDR Gold Shares ETF (NYSE: GLD). Here’s how…
How to Buy Gold At the Price You Want
GLD tracks the price movement of physical gold and is roughly one-tenth the size of the front-month gold futures contract.
And because it’s an ETF, it trades just like a stock, so you can buy and sell it through a regular stock brokerage account.
However, with it currently trading around $97, you want to wait for a pullback to the $91 area before buying, as that’s the price at which you feel comfortable owning the shares.
So what’s the best way to take advantage? Regular investors may put in a stock buy order at $91 and hope GLD comes down to that level. But if it doesn’t, you’ve wasted your time.
Here’s where the put-selling strategy comes into play.
- Instead of placing a buy order, you could opt to sell a GLD December 2009 $91 strike put option contract (GLD-XM) for $1.40 per contract.
- What does this do for us? Well, for every put option contract you sell, the option buyer will immediately pay you $140 (because there are 100 shares in each options contract – $1.40 multiplied by 100 = $140).
- If you sell 10 of these put option contracts, you’ll receive $1,400 into your trading account.
That’s right… instant cash just for placing a trade. So what’s the catch? Only that you’re obligating yourself to buy those GLD shares at $91 – which is the price you want!
However, you must ensure that you only sell as many contracts as corresponds to the number of shares you want to buy. For example, if you sell just one contract, you’re obligated to buy 100 shares of GLD for $91 by options expiration. And if you sell 10 contracts, you’d be on the hook for 1,000 shares at that $91 price.
Get Proactive Through Put Option Selling & Get Cash
So instead of just sitting and waiting to see if GLD gets back down to $91 before you buy it, at least when you sell put option contracts, you pocket $1,400 in cash (on 10 contracts) while you wait.
It’s a win-win situation: not only do you get paid money while you wait, you still gain the opportunity to buy GLD shares at the price you want ($91) if it trades back down there by options expiration.
Speaking of options expiration, let’s cover that scenario…
Your Two Scenarios At Options Expiration
Only two scenarios will occur when the December options expiration rolls around…
- If GLD is still trading above your strike price of $91, then the put options will expire worthless and you just keep the $1400 free and clear. The trade is now over.
- If GLD is trading below your strike price of $91, then you’ll be “assigned” the shares on your put options and will become a regular shareholder of GLD at $91 per share. At this point, you’ll have to pay cash in full for the shares. But remember, you get to buy GLD at your chosen price.
A few points to remember:
- You’re selling the put option contract as the opening transaction, not buying it.
- You can buy the option back any time you wish. You don’t need to wait for option expiration to take action.
- You must be approved to trade option contracts through your stockbroker. The broker will also require you to keep a portion of the money it would cost for the shares in your account during the trade (a “margin requirement”) – but not the full amount.
- If you’re assigned the shares, you simply take the same risk management actions you would for any other bullish stock position you own.
The Bottom Line on Selling Puts
If you’re bullish on a stock, but find the price is too high, why just hang around and wait for it to decline? You can earn some cash while you wait through the put-selling strategy.
If the stock ends up below your strike price (the price you want to buy the shares) at option expiration, then you succeeded in your quest. You’ll be able to buy the shares at your comfort level, while still retaining the cash paid to you on day one of the transaction. A no-brainer in my book.
Good investing,
Lee Lowell
Related Investment U Articles:
- How to Buy Gold for $100… And Get $200 Back
- How to Sell Put Options and Snag the Market’s Daily Deals
- How to Recover When Your Option Trades Turn Against You
- Put-Option Selling: Treating the Market Like Your Own Personal Costco
- The Legged Spread Trade: Take 10 Cents and I’ll Show You How to Make It $2.50
6 Responses to “How to Buy Gold… At the Price You Want and Get Paid For It”
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Along with Karim, Lee is one of America's leading options professionals. Over the course of a distinguished career, which includes six years in the options "trenches" as a market maker on the floor of the New York Mercantile Exchange (NYMEX), he has developed a proprietary trading method capable of enormous upside while actually reducing risk. 
So in your example, if GLD falls to $70 in December. I have to buy whatever amount I contracted for, at $91 a share? How can this be a no brainer?
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Well, it is not differnt from buying GLD upfront, expept the fact that if you buy it at $97 and it goes to $70, your loss is $27, but if you sell a put, your loss is less than $20 because your effective cost was $89.6. Plus it requies less margin than buying the stock.
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I am a newcomer to the options world and I would like to thank to your very comprehensible article.
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I am puzzled, why would someone give me $1400 for something I don’t own and then if the price is above what I want to pay, I would get to keep the $1400? Doesn’t make sense to me. Who would want to be out that money?
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Shirley, Remember- That payment is actually their insurance that you are going to buy this ‘thing’ from them IF it turns very bad! Even if it goes to zero you are still going to HAVE TO buy it! You are simply carrying the risk – and getting paid for it! Very much like a car insurance underwriter who takes a premium for something he does not have , other that contracting to take (buy) your car at full price from you if it gets smashed up and the value of the car is now virtually zero! Insurance companies are nothing other than PUT WRITERS! aka PUT sellers!
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Fabulous article.
Will let you know my practical results after adopting your strategy.
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