Surge in gold options above $1,000 hints at hedge fund interest

By Ambrose Evans-Pritchard
The Telegraph, London
Friday, July 14, 2006

http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2006/07/14/cngold...

A sudden surge in demand for gold options cashable at over $1,000 an ounce is the clearest sign to date that hedge funds and savvy traders are betting on a big rise in bullion prices.

UBS said investors had begun to show keen interest in "call" options to expire in December with strike prices of $1,000 an ounce and above.

The bank said buyers had even emerged for options dated late 2007 with a strike price of $2,500.

John Reade, the bank's precious metals strategist, said: "Clearly some options traders are positioning themselves for very large moves higher."

The prices are far above gold's all-time high of $850 at the height of the oil and inflation crisis in 1980. Gold closed yesterday at $653.

Buying a call option gives investors the right to buy a quantity of metal (or shares or other instrument) at a fixed price, on a set date. If the price falls short, the option expires worthless. If it shoots above the strike level, traders can make huge multiples on their stake. "Put" options act in reverse, gambling on a price fall.

Mr. Reade said: "They're like lottery tickets. You lose most of the time, but when you win, you can win big."

The December 2006 call option with a strike price of 1,000 last traded at $3.60. This means a bet of $3.60 could net $100 if gold reaches $1,100 an ounce by December, or $200 if it reaches $1,200, and so on.

Traders can re-sell options any time before expiry, making fat gains on wild volatility.

The options are traded on New York's Comex exchange, or on the Over the Counter (OTC) market. The bulk are issued by UBS, Deutsche Bank, and Goldman Sachs.

Gold has shown remarkable resilience since crashing from $730 to $544 an ounce in the May commodity sell-off.

The metal has regained more than half the ground, bringing in a fresh wave of "black box" momentum traders this week after breaking through key technical resistance at $637.

Ross Norman, director of TheBullionDesk.com, said gold was still under-priced compared to oil, trading at about eight barrels of crude per ounce compared to an historic average of nearer 15.

"Gold is due a catch-up. Once it goes above $750 there is potential for galloping price rises," he said.

Both the Russian and Emirate central banks are supporting the market, each buying the dips in a slow move to lift the gold share of their foreign reserves to 10 percent

It is hard to pinpoint why so many wealthy investors have become gold bugs, but fears of a dollar slide are a key part of the picture.

The concern is that the US Federal Reserve will ultimately opt for easy money rather than dispensing bitter medicine to purge excesses of debt and over-spending. Neither the euro nor the yen are seen as strong enough to serve as durable alternatives.

Key EU finance ministers have already said they will resist a rise in the euro above $1.30, while Japan's finance ministry is battling to hold down the yen.