Options on Gold Futures: Should I Invest?

Posted on February 15, 2021

You have many choices when it comes to investing in gold. In addition to buying physical gold, you can invest in gold futures contracts as well as options on gold futures contracts. The content below will explore what it means to invest in options on gold futures.

What Are Options on Gold Futures?

A gold option is an option that features a gold futures contract. If you hold a gold future option, you have the right to take a long position if you have a call option. Conversely, you can take a short position if you have a put option on the underlying gold futures at strike price, which is the price at which you can buy gold. That right no longer exists when an option expires after the market closes on the option's expiration date [1].

How Do People Earn Money on Gold Futures Options?

You can earn money on gold options whether the gold prices fall or rise, or even earn money if the price stays the same, when you buy gold options. Keep in mind that you do not need to hold onto an option until expiry. You can sell an option at any time to lock in your profit or to minimize a loss.

You can find gold options prices as well as volume data in the Quotes section of the Chicago Mercantile Exchange, or CME, website [2].

Call Options

If you think the price of gold is going to go up, you should purchase a call option. This type of option gives you the right to buy at a specific price until expiry, which is just a set period of time. You don't have an obligation to buy.

You will make a profit if the price of gold goes above the strike price before the point at which your option expires. On the other hand, if the gold price is below the strike price at the time of expiry, you will lose the amount you paid for your option. This amount is known as the premium [1], [2].

Put Options

A put option gives you the right, but not an obligation, to sell at a strike price for a set period of time.

You earn money on a put option if that gold price goes below the strike price. When this happens, a holder of a put option gets the difference between the strike price and the price of gold at that moment. However, if the gold prices go above the strike price when your option expires, the option is worth nothing. You then lose the premium that you paid to get the option [1], [2].

What If You Don't Think Gold Prices Will Move?

You can still earn money on gold options when you believe gold option prices are not going to move much for a longer period of time. You can either write a covered call, or you can sell a straddle to earn a profit when there's a sideways market [2].

How Popular Are Options on Gold Futures?

Options trading a popular strategy that many professional traders use. You can also create more complex strategies, called spreads, by both selling and buying options at the same time. Buying options on gold futures gives investors a way to invest in gold without buying a physical commodity or purchasing a gold futures contract outright.

Amid fears of the COVID-19 pandemic, many investors are turning to gold. This includes buying gold options [3].

What Are the Pros and Cons of Investing in Gold Futures Options?

Options on gold futures offer both advantages and disadvantages when compared to either outright purchase of underlying gold futures or buying physical gold [1].

Advantages of Investing in Options on Gold Futures

Compared to outright underlying gold futures purchases, buying gold options:

• Gives you additional leverage: Since the premium payable is usually lower than the margin requirement that you need to open a position in underlying gold futures, you gain more leverage when you buy gold options.
• Gives you more flexibility: You can use a bigger range of strategies to cater to your specific risk profile, your investment time horizon, your outlook on underlying volatility and your cost consideration if you use only options or buy options as well as futures.
• Limits potential losses: Options grant only the right to take on the underlying gold futures position, so you don't have an obligation to do so. That lets you limit potential losses to just the premium you pay to purchase an option.

Compared to buying the physical commodity, buying gold futures options offers the following:

• Risk management: Buying gold as futures options allows you to minimize and manage risks associated with the commodity.
• Flexibility: You can take part in the market without having any physical backing this way. You don't need to figure out how to store and insure any physical gold, but you can still invest in the metal.
• The ability to trade on exchange: Because futures contract trade on exchanges, you have more flexibility as well as financial leverage and integrity than if you trade the physical commodity.

Disadvantages of Investing in Options on Gold Futures

Compared to outright underlying gold futures purchases, gold options:

• Are subject to time decay effects: The lifespan of any option is limited. As more time goes on, a gold option's time value erodes.
• Have the potential to expire worthless: If this happens, you will lose the premium you paid on the option.

Compared to buying the physical commodity, buying gold futures options:

• Subjects you to market sentiment: Daily market fluctuations can be triggered by any event worldwide, and they often have more to do with hopes and fears of investors than the true value of gold. Instead of owning a physical product with inherent value, you will be trading on an exchange market.
• Isn't necessarily easier: If you're thinking about buying options on gold futures because it sounds easier than buying gold, you might reconsider. Gold coins in particular, such as the Krugerrand, are relatively easy to buy as a bullion investment.

Investing in options on gold futures gives you another way to invest in gold.

Article Sources

1. The Options Guide. 'Gold Options Explained,' https://www.theoptionsguide.com/gold-options.aspx. Accessed September 20, 2020.

2. Investopedia. 'How To Buy Gold Options,' https://www.investopedia.com/articles/active-trading/052014/how-buy-gold-options.asp. Accessed September 20, 2020.

3. CNBC. 'Options trader bets $2 million on a monster rally for gold,' https://www.cnbc.com/2020/03/03/options-trader-bets-2-million-on-a-monster-rally-for-gold.html. Accessed September 20, 2020.