Buy the Gold Miners on Obama’s Victory?
The markets took it on the chin on Wednesday, but one sector immune from the sell-off was the gold miners, who finished the day up 1.5 percent.
Just compare that to the S&P 500's 2.4 percent slide. Physical gold was virtually unchanged in Wednesday's session, but it jumped 1.8 percent on election Tuesday. (Read More: Wall Street Casts Its Vote: 'The Market Is Going Down'.)
The miners' relative strength did not go unnoticed by option traders, who bought upside calls in the Gold Miners ETF on Wednesday. The biggest trade of the day was the purchase of 50,000 November 56-strike calls for $0.06, the purchase of 10,000 November 52-strike calls for $0.56, and the purchase of 5,000 November 50-strike puts for $0.91. All of this was done with the ETF trading at $50.50.
So what's the big idea here?
Well, this is a bullish position that will profit from an explosive upward move upward in the GDX over the next two weeks. The breakeven points to this trade are $52.68 (4.3 percent higher) on the upside and $43.18 (14.5 percent lower) on the downside. While this trade will make money on a large move lower, this spread was likely designed to be a bullish play that is hedged to reduce losses on the downside.
The reason for this bullishness on the gold mining sector is likely tied to President Barack Obama's re-election, which has traders expecting Ben Bernanke to remain at the Federal Reserve, and for his easy money policies to continue. Low interest rates and the potential for more U.S. dollars in the system are supportive of higher gold prices, which in turn will benefit the gold miners.
However, as many traders have already learned the hard way, a rise in gold prices does not necessarily translate into an equal rise in gold mining stocks. Year-to-date gold is up 6.8 percent, but the GDX is down 5.1 percent. For this reason, I like to trade gold itself, rather than the miners. (Read More: Gold Rises Above $1,720; Focus Shifts to Euro Zone.)
During the first four years of Obama's presidency, gold appreciated 136 percent.
In the long run, I am bullish on gold, and expect to see it move higher. However, I trade gold using an economic model which suggests that current gold is currently trading at it fair value. Therefore, I am hesitant to buy deep out-of-the-money options on gold — much less on the gold miners. If you choose to do so, I would highly recommend keeping your risk controlled with tight hedges.
Brian Stutland is the President of Stutland Equities and a contributor to CNBC's "Options Action."
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