True Investments VS Speculative in Gold & Oil

A couple of weeks ago I was listening to an hour-long segment on CNBC with Warren Buffett. He brought up a great point about the type of investments he prefers and the difference between an investment versus a speculative trade. I feel what he mentioned is worth sharing so here it is.

He stated that he prefers to hold an investment which is earning money and generating cash flow. Meaning he prefers to own equities of companies which generate income for its shareholders versus a commodity which  does not generate any revenue.

While Mr. Buffett said that gold is a commodity everyone should own some of, he also clearly stated that buying a commodity in hopes that someone will pay you more for it later is purely speculative. Lets face it, would you rather own something that paid you monthly or annually a cash dividend or something that might go in in value, but may also lose value?

Investors and traders are primarily focused on purchasing gold stocks, physical gold via ETF’s, gold bars and coins which none of these provide any income the holder. But after doing some in-depth research I have found another way to invest in precious metals and commodities that will not only give you exposure to the gold, silver, and oil sector but it can also generate a monthly income stream to your portfolio.

Through Gabelli closed-end funds like the Global Gold, Natural Resource & Income Trust (GGN), or Natural Resource, Gold & Income Trust (GNT) you can get the best of both worlds.

Each fund is currently providing a 10% annual dividend paid out in monthly distributions. The Fund’s investment objective is to provide a high level of current income. The Fund’s secondary investment objective is to seek capital appreciation consistent with the Fund’s strategy and primary objective. Under normal market conditions, the Fund will attempt to achieve its objectives by investing 80% of its assets in equity securities of companies principally engaged in natural resource and gold industries, and by writing covered call options on the underlying equity securities.

If you don’t know what covered calls – Explained Below:

A “covered call” is an income-producing strategy where you sell, or “write”, call options against shares of stock you already own. Typically, you will sell one contract for every 100 shares of gold or oil stock. In exchange for selling the call options, you collect an option premium.

With the US stock market slowly nearing a bull market top and with commodities trading at multiyear lows we should eventually see a shift in money flows out of stocks and into commodities. With rising commodity prices resource base stocks should start a new bull market that will send these funds dramatically higher in value while still paying a juicy dividend income.

In conclusion, if you want to invest in precious metals long-term I think owning an income strategy based around that investment is a great way to add diversification and income to your portfolio. Learn more about trading ETFs, funds and copy every trade I place with my own money at www.TheGoldAndOilGuy.com

Chris Vermeulen
Disclaimer: I currently own shares of GGN

How to Trade Options Around Company Earnings

The hallmark of a professional option trader is the ability to use a wide variety of trade structures in order to exploit opportunities to profit from specific situations the market presents. One of the opportunities routinely presented multiple times yearly is the impending release of earnings.

Underlying the logic of earnings trades is the stereotypic pattern of increasing implied volatility of options as earnings approach. This pattern is so reliably present that experienced options traders can recognize the approximate date of an impending earnings release by simply perusing the implied volatility of the various series of upcoming options.

As a real time example of this phenomenon, consider the current option chain of AAPL which will report earnings after the market closes on Wednesday, January 23. (Click on each image to enlarge)

As can clearly be seen, the front weekly options, the first series in time following the impending earnings release, has dramatically elevated implied volatility as compared to the series expiring later.

It is because the release of earnings routinely causes reversion of the elevated implied volatility toward its historic mean value that a number of high probability trades can often be constructed surrounding earnings.

I thought it would be instructive to review a recent earnings trade I made in order to see how this consistently observed collapse of implied volatility works in practical terms.

EBAY was scheduled to report earnings after the market closed on Wednesday, January 16. As the price chart below reflects, EBAY had recently rallied and was trading in the price range circled in red.

At the time of the upcoming earnings release, there were only a few days of life left in the
January options which would expire the following Friday afternoon. The then current implied volatility situation can be seen in the option chain displayed below.

Note the elevated implied volatility in the January options as compared to the February options. The value is around twice that of the February options and clearly demonstrates this routinely observed spike as we also have seen above in the case of AAPL options.

My operating assumption was that EBAY would trade down slightly following earnings. This was wrong. As we will see however, proper trade construction resulted in a nicely profitable trade despite incorrect price prediction.

After considering a number of potential trades, I decided to use a short strangle in an attempt to capture the collapse of implied volatility. As a brief review, remember that a short strangle is a two legged position and consists of both a short out-of-the-money call and short out-of-the-money put.

Because my price hypothesis was that EBAY would sell off a bit, I weighted the strangle to the downside slightly by selling different quantities of puts and calls. The P&L graph of the position I took late Wednesday afternoon is displayed below.

The earnings were a bit better than anticipated and resulted in a modest price increase. I was able to exit the position shortly following the market open on Thursday morning for a profit of 6.45% based on the margin encumbrance required to maintain the position under Regulation T rules.

The results of this trade illustrate two critically important points for the new options trader to
understand clearly. First, my price assumption was wrong but the trade was still profitable. For those used to trading stock this may be almost an unbelievable result since in the world of stock trading there is no margin of error for an incorrect price assumption.

The second point is closely linked to the first. The second assumption in this trade was that
implied volatility would decrease substantially. This did in fact happen, the implied volatility of the 55 strike calls decreased from the 69.9% shown above to a post earnings release of 23%.

It was this volatility collapse in both the puts and calls that resulted in the profitability of the trade. Had I used my same price assumptions and constructed the trade using stock, the trade would have been a loser. We invite you to try our service to see how proper trade construction and position sizing can result in a high probability of success.

Article contributed by JW Jones of Options Trading Symbols

For more Option Trading Tips, visit Swing Trading Options