Buying a Covered Call On Gold Miners

Commodities Investing, Covered Calls, Gold & Silver

Gold is back in the good graces of investors as lower interest rates threaten to devalue the US dollar. Precious metals tend to be in demand as the dollar goes down, and 2019 has been no exception to this rule of thumb.

But recently, the price of gold has really taken off. For the month of June so far, gold is up nearly 9%. Year-to-date, the precious metal is up over 11%. As you can see, a lot of the bullish action in gold has taken place recently.

This is almost certainly due to the market’s expectations that the Fed will be lowering rates. After the most recent FOMC meeting, the futures market started predicting (at 100%) that the Fed will cut rates in July. Perhaps more importantly, the market is predicting 3 rates cuts by the end of the year with 70% certainty.

That’s some serious dovish action and suggests the economy could be in trouble. A shrinking economy would also be a very plausible reason for the dollar to lose ground… and for investors to move to gold.

Related: Is This Often-Overlooked Gold Sector About To Take Off?

Whenever gold becomes a popular safe-haven investment, you’ll start to see several discussions and articles about the best way to invest in gold. Some people like physical gold, like coins or bullion. Others prefer ETFs that track either physical gold or gold futures. Some investors prefer gold mining companies, which have the benefit of having a cash flow.

There’s not necessarily a right way to invest in gold – every method has advantages and disadvantages. But, as always, I believe if you can use options in your strategy, it’s generally the way to go. Gold, of course, is no exception.

That’s why I was interested a big covered call trade I recently spotted in VanEck Vectors Gold Miners ETF (GDX), the most popular ETF for trading established gold mining companies. GDX trades an average of over 40 million shares a day and more than 86,000 daily options (on average) as well.

Back to the trade, a big covered call buyer purchased 500,000 shares of GDX at $25.67 versus 5,000 October 28 calls. The calls were sold for $0.93, which means the trader collected $465,000 in premiums.

The $0.93 in premium can basically serve two purposes. It lowers the cost basis of the shares so that the long stock is protected down to $24.74. It also provides income on the trade, which amounts to a 3.6% yield in just under 4 months. Annualized, it’s roughly a 12% yield on the strategy.

Because the 28 calls are being sold, there is still a fair amount of upside potential in the stock price (with the stock at $25.67). At $28 or above the gains are capped, but the trade is maxed out. At that point, the trader can earn a total of 12.7% between stock appreciation and the short call yield.

That’s certainly not a bad deal for not quite a 4-month trade. It’s bullish on gold, but provides a decent yield. GDX does pay a dividend, but its yield is under a half-percent. This trade serves to both amplify the yield of GDX and make money if the price of gold keeps rising.

It’s also the type of trade you could easily do in your own account. You only need 100 shares of GDX per covered call, so for about $2,500 you could make this trade which provides income and gives you bullish exposure to gold.

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