Gold rally fuels exotic options

GOLD’S latest surge is drawing investors back into bullish bets, with traders turning to more creative options strategies to position for further gains in September.

Rather than simply loading up on conventional call options, investors are increasingly turning to cheaper, more sophisticated strategies to position for higher gold prices while limiting the cost of their bets, according to a Bloomberg report.

The shift comes as markets digest US Treasury Secretary Scott Bessent’s plan to “at least double” purchases of outstanding 10 years to 30 years US government debt.

The prospect of greater Treasury buying has put pressure on the US dollar while reinforcing demand for assets seen as a hedge against declining purchasing power.

Spot gold climbed about 10% in August, putting it on course for its strongest monthly gain since January, despite retreating towards the end of the month after US Federal Reserve (Fed) chairman Kevin Warsh pledged to keep fighting inflation.

Tactical approach

For investors, the question heading into September is whether gold can extend its gains without another bout of the extreme volatility that characterised the precious metals market at the start of the year.

“Investors are back on the long gold trade via both underlying exchange-traded fund demand and in the derivatives space,” Aakash Doshi, global head of gold and metals strategy at State Street Investment Management, tells Bloomberg.

“The debasement trade was on pause, never dead, in my view, and it is back in vogue heading into September.”

The renewed interest is notable because investor conviction in gold is less aggressive than it was at the beginning of the year.

Back then, concerns over the dollar’s outlook and President Donald Trump’s comments that he is not worried about the currency’s decline helped fuel a powerful rally in bullion.

This time around, investors appear to be taking a more tactical approach.

According to Bloomberg, traders have been buying large volumes of call spreads on the SPDR Gold Shares ETF, rather than outright calls.

Exotic options have also gained popularity because they allow investors to position for further upside at a lower cost.

Next leg

That could be important for the market’s next leg. Investors remain bullish, but they are also signalling that they do not necessarily expect gold to repeat its explosive gains from earlier in the year.

“This August move appears far more orderly than the price action and derivatives activity observed during the January ‘Volmageddon’ in the precious metals complex,” Doshi says.

Implied volatility in gold options has risen, but remains below the levels seen during the first quarter.

The skew, which reflects the premium investors are willing to pay for bullish options, has also narrowed.

That suggests investors are preparing for gains, but are becoming more conscious that the expected upside could be less dramatic.

“What’s different to the start of the year is that gold volatility is relatively lower, so there is a view from some investors that upside will be more capped on the next up-move and stay range-bound, for example a US$4,900 to US$5,300 range,” says Neeraj Chaudhary, Bank of America Corp’s head of exotics and flow for Europe, the Middle East and Africa (EMEA), as well as co-head of global hybrids trading.

For investors, that creates an interesting middle ground: remain positioned for gold to rise, but structure trades in a way that reduces the premium paid for the potential upside.

Bloomberg reports that dual-digital and other exotic options are increasingly being used for this purpose.

These trades introduce a second asset into the conditions required for a payout, allowing investors to reduce the cost of a bullish gold position.

Currency markets have become particularly useful in these strategies.

Chaudhary says gold versus currency pairs had been popular, with investors using the foreign-exchange leg to make options cheaper.

“For example, some investors have traded the gold/dollar-Japanese yen pair – you can buy correlation close to about negative 20% playing gold up/dollar up,” he says.

Investors have also looked at combinations involving gold and the Swiss franc, with trades structured around both assets remaining within defined ranges at maturity.

“We’ve seen requests playing gold and dollar-Swiss franc to be within these kinds of defined ranges at maturity,” Chaudhary adds.

“We’ve also seen some requests on triple binaries – for example, playing gold/oil/foreign exchange which gives you even more leverage on the payoff than the 10 to 20 times that investors usually target.”

The attraction of such trades is that investors can express a view on gold without relying entirely on the metal itself.

For portfolio managers already exposed to currencies, oil or other macro assets, combining positions can provide a cheaper way to capture a particular market scenario.

Still, the strategy comes with a trade-off.

Exotic derivatives can offer attractive payoffs, but their complexity means investors need to be comfortable with the conditions attached to the trade and the possibility that a seemingly bullish position may not pay out if those conditions are not met.

Pressure on US dollar

Gold is also not the only hard asset benefitting from renewed pressure on the US dollar.

Bitcoin has staged its own sharp rebound, although its recent performance has been driven partly by the unwinding of bearish positions rather than purely by fresh conviction from investors.

Bitcoin rose 12% from Aug 19, briefly pushing through US$80,000, after a months-long period of subdued trading.

More than US$2.5bil of bearish bitcoin positions in perpetual futures were liquidated between Aug 19 and Aug 21, according to Coinglass, helping turn what started as a macro-driven move into a sharper breakout.

US-listed spot bitcoin funds also attracted more than US$2bil since Aug 19, according to Bloomberg.

The next test for Bitcoin will be whether that momentum can survive now that much of the short positioning has been cleared.

With profit-taking already emerging, the market will need fresh spot demand to sustain the rally rather than relying on forced buying from investors caught on the wrong side of the move.

That distinction could become increasingly important in September.

If Bitcoin is gaining acceptance as a longer-term macro hedge similar to gold, continued inflows could reinforce its role as an alternative hard asset.

If the latest move was mainly a positioning squeeze amplified by leverage, however, the rally could prove more fragile.

For gold, the investment case appears broader.

Warsh’s comments at Jackson Hole boosted expectations for higher interest rates and knocked some of the steam out of bullion towards the end of August.

Yet investors have continued to find reasons to own the metal, ranging from concerns about the dollar to inflation and broader questions about the purchasing power of fiat currencies.

“Gold dual digitals have been a dominant flow over the last few months, with gold typically serving as a bullish leg within cross-asset pairs,” says Joseph Khouri, Bofa’s head of equity-derivatives structuring for EMEA.

“The reason being that the investment case for gold doesn’t rely on a single macro outcome, there are multiple scenarios where gold rallies.”

That flexibility may be what keeps gold on investors’ radar as September begins.

Instead of making a single, all-or-nothing call on bullion, the latest derivatives activity suggests investors are looking for ways to stay bullish while preparing for a more restrained and potentially range-bound market.