The gold chart looks unstable. Here’s how to make a profit

The good news is that gold is in a period of technical instability and the options market may be mispricing the risk.

While the metal is hovering around its 200-day moving average, it is also testing a 50% Fibonacci retracement of the previous rally, and technical traders are not discounting this confluence. Adding to the bearish setup, several momentum and trend indicators have reversed. The DMI, along with the triangular moving average, weighted moving average, and exponential moving average, are all pointing down.

The macro background is not much of a counterargument. Inflation stemming from the Iran conflict has heightened concerns that the Fed will take a more hawkish stance. “Longer term” interest rates have historically been corrosive for gold, which provides no yield and competes directly with real interest rate alternatives. The dollar-long risk-off strategy that could support gold as a safe-haven asset is complicated by the interest rate trajectory itself.

Friday morning’s hot jobs report doesn’t help either.

I believe that price trends will likely resolve in one of two ways. Either a decisive rebound from these support levels or a breakdown that accelerates the sell-off through a technically damaged chart. I think a prolonged range-bound price movement is the least likely outcome.

What makes the current setup particularly interesting from an options perspective is the volatility structure. The 1-month, 2-month, and 3-month implied volatilities are trading close to the 1-year average. So even though the gold price is at a critical inflection point, options are not pricing in significant uncertainty. Long options and debit spreads are fairly priced, at least in absolute terms.

Even better, the distortion was even greater. Options closer to the current spot price have fallen more than options that are further out of the money, so GLD 395/370 You can buy the July 17 put spread for about $4.10. This spread cost compression reflects two dynamics. The implied volatility of ATM is approximately 25% lower in terms of implied volatility than the lower strike price of the put spread. They also have less “vega” (susceptibility to changes in implied volatility) and a corresponding reduction in implied volatility than options with higher strike prices. As a result, spreads widen at lower prices.

This $4.10 debit will give you a maximum payout of approximately $21 at expiration. This translates into a nearly 5:1 payout ratio if GLD declines 10% over the next six weeks.

Whether deployed as an outright bearish expression or as a hedge against an existing long position, this structure has appeal. The technicals are aligned, the macro headwinds are real, the options are reasonably priced, and the risks and rewards are clearly defined. This combination doesn’t happen very often.