Gold’s Drop Presents an Opportunity

Gold dropped $20 in five minutes under this morning, and it made plenty of traders nervous. But where some saw a crisis, one big options trader saw an opportunity.

Ilczyszyn: Key Levels to Watch on Gold
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This trader took advantage of gold's decline by buying upside calls. In the biggest trade of the day, a trader bought 7,250 Gold SPDR Trust January 2014 calls for $4.35. This is a bullish trade that profits if GLD is above $204.35 at January 2014 expiration, which would be a 23% move higher in 415 days. (Incidentally, the $200 level in GLD corresponds to a spot gold price of about $2100/oz.)

(Vote Now: Where Is Gold Going Next?)

Gold fundamentals remain strong going into 2013, and while I don't expect gold to trade to $2,100/oz tomorrow, I do expect gold to appreciate significantly.

This is based on simple supply and demand.

The supply of gold is not expected to increase dramatically next year, but demand should continue to grow. Why might we see more demand? Well, let's look at the two primary sources of gold demand: central banks, and exchange traded funds. In 2011, net central bank purchases exceeded 455 tonnes, the most since 1964. This year, the World Gold Council has reported that net central bank purchases make up about 20% of global supply. Meanwhile, demand for gold from investors has also been strong, which has led to over $200 million in inflows to the GLD in this month alone.

(Read More: Gold Plunges on Commodities Rout, Dollar Jump)

Taking the thesis one step further, I trade gold based on a fundamental macroeconomic model, which currently suggests that gold's fair value is $1785. I am closely watching the Fed's activity and how it affects the US monetary base, as well as movements of the euro, U.S. bonds, and the U.S. unemployment rate.

(Read More: If Gold Fails to Cross $1,800 Soon, Expect a Steep Fall: Chart)

While we are certainly bullish on gold, our model suggests that $2,100 is somewhat of a pie-in-the-sky goal, and not a realistic target given current fundamentals. That said, should gold be higher than it is now? The answer is YES! Therefore, while I would not hold this option to expiration, the 200-strike call is likely to appreciate in price in the near term on a pop in gold.

Disclosures: Personally, I am long GLD for myself and clients, along with being short the December $173 covered call.

Brian Stutland is the President of Stutland Equities and a contributor to CNBC's "Options Action."

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