FxWirePro: XAU/USD collars to hedge medium term uptrend participation

Gold for December delivery on the Comex division of the New York Mercantile Exchange hit an intraday peak of $1,166.40 a troy ounce, the most since August 24, before trading at $1,164.50 during European morning hours, up $8.60, or 0.74%.

As per our prediction in our previous posts gold has gained from the lows of 1111.54 levels to the current 1137.54 levels. There is no floor trading on the Comex today because of the Columbus Day holiday in the U.S. All electronic transactions will be booked with Tuesday's trades for settlement.

If you think the prices of this precious metal are to spike up further, then cover your underlying exposures with collars strategy. Gold futures rallied to 7 week highs today amid growing expectations that the Federal Reserve will hold off on hiking interest rates until 2016.

When above fundamental reasoning bothers your trade sentiments, this strategy is for those risky traders who have this commodity exposure at present and are concerned about a correction and wish to hedge the long spot commodity position. How do you do that? Well the hedger takes following positions constructs this strategy:

Write an OTM call option + hold an ITM put option (near month Call & mid month put). Writing OTM calls may likely to fetch certain returns since any abrupt slumps in near future may be taken care by this instrument.

This helps as a means to hedge a long position in the underlying outrights by holding longs on protective put. Thereby, any declines in this commodity would be taken care by ITM put options since the holder of the put option will have right to sell at predetermined strike price at expiry in case of American style options.

Maximum return = Strike price of call - Currency spot price - net premium paid or Strike price of call - Currency spot price + net credit received on short side.