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Digger v Bullion – Play Them Both

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A quick look at some open trades to start.

This one recently turned in our favor:

Way back at the beginning of October of last year, in Picnic Basket Pairs Trade, we took two food companies, General Mills (GIS) and Tyson (TSN), and wrote a zero premium options trade that immediately turned against us.

We admit, it was not a pleasant experience, but we gave ourselves lots of time on the trade (April expiry), and remained confident that things would eventually turn around, and as of last week we were vindicated.

General Mills shot convincingly higher, and Tyson pulled back.

As of Friday’s close, our options looked like this:

Long GIS 41 CALL – $5.45

Short TSN 18 CALL – $5.20

That’s right, we’re in a measly profitable position, but it’s good enough. We’re jumping. We simply don’t have faith that recent price action will continue much longer in our favor.

Take a quick look at the charts.

WSE03051311

General Mills climbed 17% in the last two months on stronger volume and pushed well into overbought territory, where it still resides (in blue, at bottom).

And that looks dangerous to us.

Here’s Tyson for the same period:

WSE03051322

Despite the fact that TSN is starting to break down technically, falling below its short term MA (red circle) on increasing volume and cratering from an overbought RSI reading to below its waterline, we still feel it’s prudent to cash out.

Yes, there may be some juice left in the trade, but time is running short and we’re not convinced that GIS will hold up indefinitely here against a broader market pullback. Even if both stocks decline, they may not do so in a pattern that’s favorable to us.

We’re gone. With a paltry $25 per pair.

And a smile.

Dollar Cruising

Let’s look now at a second trade – our open CALL position on the dollar issued on November 26th in Black Friday Puts the Dollar on Sale.

In that letter we recommended you purchase the June expiry UUP 21 CALLS, then trading for $1.06.

As of this Friday’s close, we’ve seen a beautiful gain in the option. It’s now fetching a lovely $1.47, a gain of 39% since we opened, and here, too, we’re calling it a day.

Not because we think the dollar’s run is over. We’ve made our position on the dollar abundantly clear here – we’re unabashed bulls and see plenty more upside over the medium to long term for America’s fiat paper. But here, too, we feel the move has stalled, and we’re not wont to play games when a general market pullback might also force the dollar to recede ground.

Here’s the technical setup.

 

WSE03051333

 

So we’re out.

There’s not much more immediate upside to the trade, as far as we can tell. The rise was extraordinarily steep, and it’s logical to assume there may be some give-back in the coming days and weeks.

And Here’s One More

Finally, just an update on last week’s call to sell the PowerShares DB Commodity Index Tracking Fund (NYSE:DBC).

Looks like we put on the trade just in time. Have a look at what’s happened since:

WSE03051344

DBC is now oversold after registering a hit on the RSI 20 line (red box). We should therefore see a bounce, but a new bullish leg is likely not in store. After support at $27.15 was taken out (blue circle), the technical damage remains for DBC, and a bottom will not likely be in the works until we see more significant and sustained volume figures.

We have another half year on this one, so we’re holding.

Gold Digger Check Trade

This one needs your full attention.

Gold has been falling since its highs were set back in the summer of 2011, yet a look at the Kitco website would have you believe that the entire decline was just business as usual – a few, mere bumps on the road in the midst of an ongoing rocket-shot to wealth.

Alas.

We mention the Kitco website not to cast aspersions. No, and no again. We do so only because Kitco is a hub. Everyone who’s interested in gold investing eventually ends up there to get price updates and/or to read commentary. And the influence of the sight is substantial.

Yet wouldn’t you know it, for those same eighteen months we don’t recall seeing any post suggesting gold was headed lower for any more than a hiccup – a brief jag down before the floodgates of desire would reopen and send the shiny metal smacking its tender head on a $10,000 ceiling.

And so it remains today. With both gold and the miners taking a beating to the point that both recently registered deeply oversold RSI readings, the Kitco commentaries are still awash in Panglossian bullitude.

A quick survey of some recent headlines reveals the following gems:

Gold Setting Up a New Bottom

Everything Poised for a Higher Gold Price

Gold is Nearing a Bottoming Zone

Bullish Gold Supply

Gold Completing a Cyclical Low in February

 

[We especially like the third item – gold is not bottoming, nor is it nearing a bottom, it is, rather, nearing a ‘bottoming zone’! What the hell?!]

Now, we’re not fortune-tellers, so we’ll close like this. Maybe these folks are right. Maybe the leg to $10,000 gold started last week. We just can’t help being a bit cynical when this is the analytical fare served up on that site 24/7 all year round.

So how do you trade it?

We actually believe there’s more downside ahead for the PM’s, so we’re coming at this from a different angle altogether – one that we believe is safer and more likely to produce profits.

Take a look at the chart below of the SPDR Gold Trust (NYSE:GLD) charted against the Market Vectors Gold Miners ETF (NYSE:GDX) for the last year and a half.

What’s clear from the chart is that when these two stocks diverged last May to register the same deeply oversold RSI readings that we’re seeing today (red circles), there was a significant snapback that followed (black circles).

Look here:

 

WSE03051355

 

It appears we’re now at a similar juncture.

RSI is just as oversold today, while the spread between the two stocks is even wider than it was back then.

We’re therefore betting that the gap between the two will tighten, just as it did through the summer of 2012. And we’re going to play it with CALL options.

 

Wall Street Elite recommends buying the GDX December 38 CALLS, now selling for $3.50 and selling the GLD December 168 CALLS for the same price, in equal numbers.

 

The trade costs nothing but commissions to initiate and profits as the spread between the two narrows.

With kind regards,

Hugh L. O’Haynew, Senior Analyst, Oakshire Financial

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Comments

3 Comments on "Digger v Bullion – Play Them Both"

  1. Rodd Mann on Tue, 5th Mar 2013 7:48 PM 

    In terms of odds these trades rank somewhere between the craps table and blackjack. You’re dealing with far too many unknowns to gamble with any sense of prudence. Such a high risk trade, such a paltry return, but be grateful, could have been much, much worse in the end. You were lucky.

  2. Eric L on Tue, 5th Mar 2013 9:23 PM 

    This pair trade thru options is a great idea. Normally, I use the difference of ROCs (Rate of Change) of two underlyings to decide the timing to execute pair trade. Currently the difference of two ROCs (GLD’s ROC(50)- GDX’s ROC(50)) is 15.03, which is very close to previous high- 17.03 in 05/15/2012 as stated in the article. I believe the timing to execute this strategy is about right but market will decide the P/L. Good Luck!

  3. graydrake on Wed, 6th Mar 2013 1:39 PM 

    I like the concept, but I do not I like this specific trade. Assume they recover in the same relative percentage that they fell since the recent high (GlD moved down 10% and GDX 34%), we must see a gold increase of at least 8% for breakeven. Anything below this, will be a loss – the smaller gain the greater the loss.

    Drake


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