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The bullion prices continued to trend higher last week (spot prices up 1.6% wow to end the week above $1,780/oz). Gold front month ATM vol ended last week where it started, at around 16 vols. We refer JP Morgan’s machine learning based 1M ATM vol model has been showing a moderate sell vol signal for the past week so we are leaning towards selling short term near the money vol.
The 3m positive skewness of gold options contracts implies more demand for calls (refer 1st chart). These skewed IVs of 3m XAUUSD contracts are still indicating the upside risks, bids for OTM call strikes up to $1,900 is quite evident that reminds us hedgers’ inclination for the upside risks.
One could also see the fresh negative bids for the existing bullish risk reversal setup. To substantiate the above-mentioned bullish sentiment, risk reversal (RRs) numbers also indicate the overall bullish environment (2nd nutshell). Well, we know that options are predominantly meant for hedging a probable risk event in future.
We also expect the extremely strong positive gold spot momentum to continue and so we recommend selling 3M ATM puts for 17.01% vols and buying 3M 25D puts for 18.95% vols with an equal notional, indicatively.
Hedging Strategies:
Capitalizing on all the above fundamental drivers and OTC indications, we advocate longs in gold via ITM call options as they look to be the best suitable at this juncture.
Thus, we still advocate buying 3m XAUUSD (1%) ITM -0.69 delta calls on hedging grounds. If expiry is not near, delta movement wouldn’t be 1-point increase with 1 pip in the underlying movement, which means if the spot moves 1 pip, depending on the strike price of the option, the option would also move less than 1.
Thereby, in the money call option with a very strong delta will move in tandem with the underlying spot gold prices as we could foresee more upside risks and intensified buying interests on safe-haven sentiments amid geopolitical turmoil and the global financial crisis. Courtesy: Sentry and Saxobank
