2017.04.2809:35:00UTC+00Fxwirepro: Gold Price Hedging - 3-Way Straddles Versus Otm Put on Bullish Neutral Rr and Shrinking Ivs

Gold firmed on Friday as forecast-beating euro zone inflation boosted the euro against the dollar, while global stock markets retreated from Wednesday's record highs as concerns about global trade subdued appetite for cyclical assets.

We reckon the below OTC indications and trend in bullion markets seem to be reasonably addressed by hedging participants, hence, we advocate below option strategy to mitigate uncertainty hover in spot gold prices, the strategy likely to keep underlying price risk in check regardless of price swings with cost effectiveness.

Spot gold was up 0.2 pct at $1,266.11 an ounce at 0945 GMT, while on the Comex division of the NYME, gold futures for mid-month delivery (June) were little changed at $1,266.36.

Hedging Framework:

Strategy: 2m 3-Way Diagonal Straddle versus OTM Put
Spread ratio: (Long 1: Long 1: Short 1)

Rationale: Let’s glance on sensitivity tool, the bullish neutral risks reversals indicate upside risks in underlying spot gold prices, while shrinking implied volatilities signify the put writers’ advantages.

Please also be noted that the 1W ATM puts are exorbitantly priced above 57% more than NPV, while 1w IVs just shy above 11%, this disparity should optimally be utilized in below option strategy.

For 2m IV skews would signify the interests of OTM call strikes that mean the ATM calls higher likelihood of expiring in-the-money, so writing overpriced OTM puts would be a smart move to reduce hedging cost.

The execution:

Go long in XAUUSD 1M at the money -0.49 delta put, and go long 2M at the money +0.51 delta call and simultaneously, Short 2W (1%) out of the money put. Thereby, we favor bulls as we foresee more upside risks by keeping longer tenors on call leg.