Bitcoin Halvening and Crypto as Money

Does a cryptocurrency need to represent a store of value to be successful over several years? Crypto as Money and Bitcoin Halvening - Bitcoin Split Photo - 20200507

Bitcoin Halvening image from this original photo under license

Bitcoin Halvening

One aspect of money is as a store of value. Value can be created by scarcity, that is literally limiting supply of any currency. Assuming there is more demand than supply for the currency, then it’s price should rise (becoming a store of value). By design many cryptocurrencies have built in scarcity because they will only create new coins on predictable supply curve. One aspect of Bitcoin’s approach to this is the “Bitcoin Halvening” that occurs approximately every 4 years (every 210,000 blocks). On a specific Bitcoin Halvening date the amount of Bitcoin supply that can be awarded to a miner on each block is reduced by half. On average a miner can therefore except to receive half the amount of bitcoin for solving the same problem. After the Bitcoin Halvening date passes, this literally halves the supply of newly minted Bitcoin overnight. As a reminder the only way Bitcoin comes into existence is by being “mined”. Bitcoin mining is solving a complexity computer problem becomes progressively more difficult solve using existing computing hardware. If a bitcoin miner (a piece of computer hardware) solves the problem, they are entitled to keep a certain amount of bitcoin from latest block they solved. The scarcity comes from the fact that currently computing power is finite, so the “block solving” problem is hard to solve. If one miner’s computing power was somehow instantly improved by a huge magnitude for several months, then that miner would simply be able to mine the majority of available bitcoin. This is because the fast miner would be able to solve the computing problem before any other miners, so all other miners would not receive as many bitcoin rewards. Bitcoin scarcity therefore relies on finite computing power, essentially enforced by the current hardware speed.

Gold Cryptos

Both Bitcoin and Gold are a store of value because they are scarce. Bitcoin comes into existence via a computer hardware “mining” process, and is assigned market value because it takes lots of computing resources to create. Gold already exists in the ground, but becomes usable only after intensive exploration and physical mining operations. Gold is a hard to find metal that is first located through exploration. Gold then needs to be extracted with an energy intensive physical mining process to remove and refine the raw metal. Therefore Gold has value because it is hard to find and refine. With both Gold & Bitcoin the difficulty of their mining process helps maintain scarcity and is one reason that lets them act as a value store.

Recently there have been some new crypto tokens that have create a coin backed by real world assets. These “real asset” crypto tokens represent a true claim on a financial asset, not simply the tokenisation of a technology idea. For example PAX Gold is a very new product launched in Sept 2019 that combines advantages of blockchain and gold, with each PAXG token being backed by exactly 1oz gold. However “real asset” cryptos that represent a real world asset still come down to one word – trust. The entire system hinges on trust, specifically that you can provable verify that 1oz of gold in a London vault is actually really represented by the 1 token in your wallet. If you can have trust in the company auditing, it can be a very innovative way to store wealth on the blockchain.

Crypto Sectors

Bitcoin has been alive for over a decade, and many other crypto coins have been around for five years or more. “Long term” is relative – in crypto it is probably any coin or token that has been alive for more than five years. Widespread adoption is both a critical measure of success for a crypto to be considered currency like “medium of exchange”. Currently those who believe in Bitcoin Maximalism appear to have an edge as first mover in the currency space, as Bitcoin has the largest payment adoption and approximately 65% dominance of all crypto market cap in April 2020.

Crypto is notoriously hard to place into neat boxes. However if there is such as thing as crypto “sectors”, then some candidates would be “currency”, “privacy”, “tokenisation platforms”, “real assets” and “utility coins/tokens”. In currency, privacy and tokenisation platforms “sectors” there is nearly always the first mover that the advantage. For example Bitcoin (BTC) is considered the primary currency coin, Monero (XMR) the first mover for privacy and Etheruem (ETH) the first token platform. However due to the huge array of use cases it is hard to define one single “winner” from all the utility tokens/coins.

As a very general observation in 2020, currently crypto projects that act as money or enable tokenisation seem to be the main winners. Crypto needs to either be used as a store of value, be asset backed or provide a tokenisation platform (the plumbing) to allow the value tokenisations to occur. Crypto projects that only rely on a technology or business idea to “create value” do not appear to gain market cap long term, even if the project is succeeding with its technical objectives. Many crypto projects are finding it hard to build their own ecosystem, because investors tend to get focused on a few winning projects, while the rest die. Essentially there a few categories of use cases, with winner take all in each one. The losers die off slowly over several months and years. This is not necessarily because a project “failed” from a technical perspective, just that it failed to consistently attractive new capital to justify a higher price.
Increasingly crypto that have highest market capitalisation are maturing into money (for exchange), a real asset (that has real world value outside of crypto) or the tech platform that enables tokenisation. The next wave of cryptos with long term staying power could to be tokenising financial “real assets” in the real world, not simply to tokenise a whitepaper idea.

Below are some “sector” examples. Nearly all of the top 20 coins are currency, privacy or token platforms. There are few true utility coins/tokens with larger market caps, but some interesting use case projects are listed below. These are not exhaustive list, just an overview. For reference, here is the latest and greatest CoinMarketCap ranking list.

Currency : Bitcoin (BTC), Ripple (XRP), Litecoin (LTC), Decred (DCR)
Privacy: Monero (XMR), PIVX (PIVX), AEON (AEON)
Real Asset : Tether (USDT – USD stable coin), Pax Gold (PAXG – physical gold)
Token platform : Ethereum (ETH), EOS (EOS), Texos (XTZ), Neo (NEO)
Utility coins/tokens: Salt (SALT – Crypto Lending), Filecoin (FIL – Storage), Golem (GNT – Distributed Computing)

Crypto as Money

Currency and privacy are related aspects of money. Sometimes there is a somewhat artificial distinction made between “currency” coins that function as “money” and “privacy” coins do “private transactions”. However surely two main requirements of money are both privacy and fungibility? Cash banknotes traditionally have a high degree of privacy, even though they are sometimes tracked by law enforcement by serial numbers. Generally each banknote is interchangeable with another – one banknote of the same amount can be exchanged by two parties for another banknote with the amount. The specific banknote itself is not important, just the exact value it represents.

Confidence in the liquidity and fungibility of any currency is a crucial factor enabling adoption. However Bitcoin is clearly NOT fungible. Indeed any crypto “currency” coin (not just Bitcoin) with publicly visible blockchains allows positions and transactions on coin addresses to become fully traceable with more advanced analytics. As long as you can identifier a natural person (owner) of a bitcoin address via some method, you can see every transaction they make on the blockchain and their current address balance. This would be equivalent to your bank publicly showing on their website, all of their customers transactions and month end balances – just without any personally identifiable information. An alternative way to think about this, would be if every banknote in the world had a public list of every transaction it has ever been used in since it was created (just without the name of the from and to parties involved in the transaction). It is doubtful if consumer privacy advocates or customers would accept this with a “real world” bank.

This everyday reality for Bitcoin or any other publicly visible blockchain is becoming problem. It means that individual Bitcoins have a full history. If you can piece together all the owners of the addresses via social engineering or know your customer rules, then all of Bitcoins anonymity disappears. For example, most crypto exchanges (and any “on ramp” into the cryptosphere) require a large know your customer regulations (e.g. driving license, passport, proof of address etc).

This blockchain forensics is a problem because it basically breaks the fungibility of Bitcoin. This analysis allows identifying “good” bitcoins that have never been used for any thing questionable, and “bad” bitcoins that have (perhaps unwittingly) had some criminal use. For example, assume you open a small business selling coffee that can legitimating accept Bitcoin payments. If a dubious actor decides to use their “bad” bitcoin to buy your coffee, your legitimate coffee selling business could have it’s crypto exchange or bank accounts shutdown for dealing with a “bad” actor. This could occur even if the majority of your business was with “good” bitcoin. The issue is that the “good” and “bad” bitcoin decisions are not decided by yourself, they are decided by the crypto institutions (e.g. exchanges) you signed up with.
The “real world” cash equivalent would be something like being banned from your local coffee shop, because you used a bank note previously involved in a historical crime committed by different person.

Monero (XMR) is the only privacy coin to fully resolve this fungibilty issue by design. There are many technical features that ensure Monero fungibilty, but two features to highlight are 1) not having publicly viewable transactions on a blockchain and 2) having read only view keys.

Monero less transparent blockchain, where the specific transaction history of a coin cannot be viewed. Therefore 1 XMR will always be the same another 1 XMR – it doesn’t matter how the individual coin has been previously used. Monero is much more similar to cash (banknotes) because it is untraceable, whereas Bitcoin is trackable digital money.

As transactions are not viewable on Monero blockchain there needs to be some way for other parties to be able to verify holdings without controlling them. With Bitcoin the public blockchain does this because you can send anyone an address to look up. Monero has the concept of view keys give the ability to prove address balance to only interested parties (not the entire world).

Some other cryptos do have privacy features, but typically they are not enabled by default. Typically a privacy feature has to be “turned on” for a specific transaction. Some coins are therefore “private” (privacy enabled) and “public” (default), so these coins are by definition “different”. Therefore even in the same crypto coin since the “private” coins are not viewable on the public blockchain, as they are not identical to “public” coins. This means that coins are not truly fungible even within the same crypto. Monero is private on the actual protocol level with the option to be transparent, whereas with Bitcoin every transactions will by definition only every be “psuedo anonymous” because of the publicly viewable blockchain. Monero (XMR) is unique because the idea of privacy is built in by design.

If you are interested in learning more we have written an Amazon Kindle eBook Better than Bitcoin – A Beginners Guide to investing in Monero.

COVID-19 Coronavirus Portfolio

This is a COVID-19 coronavirus portfolio of trading ideas generated in the last two months. The portfolio aim is to identify and invest in new trends in commodities or sector ETFs generated by either government policy monetary policy response or “shelter in place” lockdowns.

Covid-19 coronavirus portfolio - world map - 20200416

This collection of trading ideas was setup somewhat quickly as a tactical portfolio in response to the COVID-19 Corona Virus situation. The fundamental portfolio theme is that the market has been almost instantly split into winners and losers, Some industries have simply been decimated overnight that they can’t function as viable businesses for the immediate future. For example, even Warren Buffet completely sold all Berkshire Hathaway’s US airlines in April 2020. The aim of this tactical portfolio is to think about trading ideas that can generate winners in the “new normal”.

COVID-19 coronavirus portfolio – Option Volatility

Volatility is very high in most commodities and sectors, so it is critical to use option trading strategies for high volatility environments. Specifically Implied Volatility Rank (IVR) is in the range of 75% to 100% for many ETFs this month. Simple one leg option strategies such as buying out of the money calls in high volatility products will likely not do well. The “go to” trade on ETF options has typically been to buy long dated deep in the calls (LEAPs greater than 9 months out). This means that the majority of premium paid is intrinsic not extrinsic (time) value – the extrinsic value will likely reduce over the course of several months as the current volatility premium likely goes lower. To help with any downside, call spread overwriting and put butterflies on the same ETFs. There was also call spread overwriting in major tech indexes to hedge some downside in tech ETFs that do not have any options. Where no ETF options were available, actual ETF equity positions were taken, but sized appropriately at less than 10% of portfolio size.

COVID-19 coronavirus portfolio – Trade Ideas

The exact thinking behind the ideas need more detailed separate blog posts to fully justify their inclusion. However this tactical portfolio blog post is just to give the trade ideas, their high level implementation and any hedging strategy. This following ideas show the sector, idea rating (buy/hold/sell), the conviction level (low/medium/high) and a high level idea description.

New trades with “Buy” where started in the last 45 days. If a “Hold” is included in this portfolio that means it was already owned, but think performance would improve because of COVID-19 Corona Virus environment. The aim would be to hold most of these for 2020, or until stopped out.

Each paragraph describes a trade idea within a sector (including trade direction), rating (Buy/Hold/Sell) and overall conviction level.

Real Estate and Liquidity

Real Estate (Long). Hold/Buy. Medium. Select international opportunities mostly due to strong USD creating weaker local currencies and lower prices on local real estate. Here “local” means local to a target country in question, specifically Canada and UK whose currencies have been beaten up quite a bit due to flight to safety buying of USD. Keeping liquid in USD to maybe a currency conversion later in 2020 for a property purchase. Not rushing into anything. Actively writing a new Ebook for US investors on future opportunities with international real estate in 2020 and beyond.

Metals

Gold (Long). Buy. High. Gold is one of the best performing assets YTD in USD, and rebounded very quickly with after an initial March 2020 sell offs. The rebound was a direct response to the FED stimulus packages for the general economy. Gold is trading at 7 year highs in USD (near $1700) but importantly gold has made already made new all time highs in just about every other major currency such as Euro, UK Pounds, Canadian Dollars (etc). Select currency and 20 years on this Bullion Vault to chart historical gold price in each currency. Bought deep in the money calls on physical gold ETF (GLD) with an approximately 90 delta for Jan 2022. Aim is maintain a gold position, to ultimately replace with some actual physical gold, when the current spot to physical price premium subside. Aside from just the physical metal, gold miners should benefit from lower oil prices and therefore have reduced input costs, that should increase earnings per share in 2020 and beyond. Gold miners are up about 30% since purchase of Jan 2021 deep in the money calls in both major (GDX) and juniors (GDXJ). These are potentially multi year longs.

Silver (Long). Buy. High. The gold/silver ratio is at about 113 which means that silver is historically very undervalued compared to gold. Interestingly the silver price is approximately tracked the Dow (DIA) year to date, being down about 15% – so it does have more of an industrial market supply and demand component. Gold tends to function as a true safe haven, but silver can influenced by industrial supply and demand from economic conditions. Silver can definitely sell off in a general market downturn, where as gold is holding its value better. However if there is to be a significant gold bull market, silver will tag along for the ride, but may take more time to turn around. Trade was bought physical silver and silver metal (SLV). Bought deep in the money calls with an approximately 85 delta for Jan 2021.

Uranium mining stocks (Long). Potental new uranium bull market for 2020s. Uranium producers and explorer stocks have been one of best performing sector and are up YTD – beating general indexes. Uranium equity could definitely get caught in a wide market downtown, but has tracked higher physical uranium prices that have increased from low $20 to $32 in last month. Ideally this is a very specific sector mining play that should be a play on the physical price of uranium, and should not be correlated to the general market. We play this with a small position in a very small ($4 million market cap!) and brand new ETF of uranium producers URNM. This could be a multi year trade, but the risk reward setup seems good.

Energy

Oil drillers (Long, short vol). Buy. High. Added new full size positions in OIH. Made bullish call last month on OIH was trading at around $4. In OIH sold cash secured $3 puts in July 2020 and Sept 2020, because the implied volatiliy was insane (over 100%), and combined with half a position in long OIH stock. This position bounced nicely, so bought back the short puts for good profit, then hedged the remaining stock with a wide put bufferfly in July 2020. Sold 40% out of the money call in July 2020 to help finance the put butterfly a bit. This is neutral to long ish bias on OIH until July, but it has run up a lot in April so it is sells off in May (seems likely to take a break) then the put buttefly will make some good money, even if the OIH stock loses money. Note that OIH has had a 20:1 reverse split this month, so the $ option strikes mentioned above will need to be multipled by 20 to compare to a current OIH chart.

Oil explorers (Long, short vol). Buy. High. Added new full size position last month on XOP (same timing as OIH trade). Bought a deep in the money for Jan 2021, then overwrite with call spread for May 2020. The call spread recently had both legs in the money and was only 2 weeks to go to expiration. Therefore overwritten call spread was rolled to Jun 2020 for a minor debt. The aim is to maintain the deep in the money Jan 2021 call, and keep overwriting for the rest of the year. If XOP goes up a lot we will capture majority of move. If stays same we can get some income from the high volatility in the call spreads (if they expire worthless). If goes down we will lose, but much less than stock. One advantage is if XOP price goes down fast the implied volality will go up, and so the deep in the money call will stay bid. Note that XOP has had a 4:1 reverse split this month, so the $ option strikes mentioned above will need to be multipled by 4 to compare to a current XOP chart.

Natural Gas (Slightly long, short vol). Hold. Medium. The natural gas etf (UNG) is hard to hold long stock for several months, due to the current contango in natural gas futures. Contango is when near month natural gas futures trade lower than far month future prices. (UNG) maintains its natural gas price exposure by constantly rolling contracts – specifically buying more expensive far month futures contracts, by selling the expiring (and cheaper) near month contract. This enforced rolling built into the product, creates a long term drag on prices while natural gas is in contango (look at any multi year chart of UNG). This is a less extreme version of the same problem with USO contango this week – when the oil price went negative (!). Since owning (UNG) stock is not a good idea, the setup is usually buy a long term calendar call spread, and also selling near dated call spreads on (UNG). This takes advantage of high implied volatility with limited risk, but can still benefit if prices are higher or neutral. This does sacrifice large profits if (UNG) spikes higher quickly and cannot roll fast enough into the price increase.

Natural Gas Producers (Long). Buy. Medium. US natural gas equities have been beaten up in 2020. Clearly there are is a huge over supply of natural gas and a massive worldwide demand shock for energy. (FCG) tracks an equal-weighted index of US companies that derive a substantial portion of their revenue from the exploration & production of natural gas. Approximately 15% of its portfolio is in MLPs and the remaining 85% to equities. Interestingly the (FCG) attempts to recovers some of its 0.6% management fee by securities lending, and it does have a dividend yield but that will likely disappear to much smaller amount in 2020. However to place this in some historical context, many US natural gas equities are trading at the lowest price for 20 years. For example, buying natural gas producers index (FCG) for $5.50, when its all time high is about $155 in July 2008. The US natural gas producers sector at these prices is low enough to be a binary trade. Either the majority of the US energy complex is going bankrupt and this is a slow grind lower for many years (“lose”). Alternatively some energy demand returns, the survivors consolidate and a restructured sector operates at higher price levels at some point in the next few years (“win”).

Equity

Cloud Computing (Long). Buy. Medium. More e-business activity (e.g. Shopify) for starting new businesses and tools for people working for home. This is long equity ETF but focusing on cloud technology (CLOU). Actively trying to ignore struggling parts of economy (e.g. airlines, manufacturing, automative, consumer financing etc). Positions in CLOU and other tech ETFs will be actively hedged with QQQ OTM call spreads.

Mortgage REITs (Long). Buy. Medium. MReits were trading at significant discounts to book value in April 2020 This was definitely a speculative buy with high yields around 11%, especially because dividends could be heavily reduced in next year. However if MReits can simply maintain their value, and allowed to DRIP for a number of years (even at these levels), then they can add some welcome yield and maybe some capital appreciation. MReit ETF (MORT) is a high yield trade great for a portfolio position in an IRA, because it can be allowed to DRIP long term. This is relatively risky play, and only medium conviction. There is no simple way to hedge this using options, so will only take a half position size to manage the risk.

Solar ETF (Neutral). Sold. Medium. Fortunate enough to sell Solar ETF (TAN) around $34 after the bounce back up to $37 in early March 2020 (not the top, but about 20% off the high the way down). This was a risk off trade, which preserved some capital initiate some of the other new ideas in this portfolio.

Emerging Market Equity (Short). Buy. High. Emerging market companies that have debt denominated could have a hard time paying it back, with economic shutdown and currencies depreciating against USD. Emerging market equity like Brazil (EWZ), Mexico (EWW) and India (INDA) have not bounced back as fast as the main US equity markets. For example Brazil has traded in an approximate range of $21 to $26 over last month, down from a Feb 2020 peak of (this is a “L” market chart, not the “V” market chart). Two trades here were 1) out of the money Long Put EWZ butterfly in May 2020, fully financed with short call spread on India market (INDA). This was neutral to bearish. 2) in the money Long Put EWZ butterfly in May 2020 for a debit, and no short call spread. This was more bearish. Brazil equity market has proven to be weaken than India in April 2020 so that seems like a good trade choice approaching May 15th 2020 expiration. INDA trade should expire worthless. Brazil trade already in the money and likely to still be there closer to expiration.

High Yield Corporate Debt (Short). Buy. High, now Medium. Corporate credit quality is being impacted by an unknown amount due to corona virus shutdowns, so that uncertainty would cause high yield corporate bond ETFs to trade significantly lower in the next couple of months. Entered an in the money (ITM) put butterfly as a limited risk reward way to short high yield bond ETF (HYG) on 17th March. HYG was at about $77 then went down 10% in a hurry to around $70. The risk was managed with the limited risk trade structure of an ITM put butterfly, but still got “taken to the cleaners” by the announcement that the FED would be buying junk corporate bonds. This policy announcement caused a huge HYG rally in April from about $70 to $80. Unless there are signs a sharp move down in high yield this week, it will be closed this week approximately 10 days before 15th May expiration – losing about two thirds of original trade capital this week. This is to preserve one third of the remaining principal from a losing trade, as a put butterfly that is now out of the money will decay much faster into expiration. A classic example of a good initially profitable good trade entered for the right reasons, but taken out by unprecedented policy decision. Trade was a loser, but have successfully managed the short risk by not having an unlimited short risk trade on.

Crypto

Cryptocurrency (Long). Hold. High. Bitcoin (BTC) and other alt coins (e.g. XMR). Holding not adding any more.

Liquidity and Hedging

Peer to peer lending – Lending Club (Neutral). Sell/Hold. High. Already dialed back risk here several years ago due to lending club management issues. However this month turned off auto re-investment of cash into new notes. Definitely do not want any more exposure to consumer credit for next year or so. Peer to peer is a small position, but turning off re-investment seems prudent until can figure out what is going with the general consumer lending (does not look good in short or medium term).

Cash (Long). High. Long USD for investment opportunities and saving up to get properties with low LTV. On existing international property businesses we are looking to open small home equity line of credits on properties with low LTVs in local currency (assuming local bank allows it). A small amount of debt exposure in local currency is effectively a long USD position (since we are based in USD). If the local currency for a country where we own property declines significantly we may consider paying down mortgage principal from USD cash.

Hedges (short, combined with underlying positions). Buy. High. Index call spreads overwriting out about 2 months. similar idea to covered covered calls, but with limited risk reward so that if the market does go massively higher are not losing so much (and can probably roll out of it in following months). Selectively combining put butterflies with hedges.

COVID-19 coronavirus portfolio – Summary

This tactical portfolio was created relatively quickly. The main themes were long metals and energy, with some technology and potentially some real estate later in the year. There are also some relatively aggressive hedging and other complimentary short positions. This is a long/short portfolio, that would be much more heavily hedged if world goes “risk off” again. Having good entry points in April 2020 should definitely help holding positions for longer term. The other main theme is keeping very liquid and not over allocating to make sure money is available for opportunities. In summary, only trade if you want to, not because you have to.

Trading Gold Long Term Diagonal Spreads

This trade idea shows how to approach trading gold with long term diagonal spreads. The trade example shows how a bullish multi month GLD long call diagonal spread was entered and managed. This trade was IRA eligible so using multiple option legs does not generate lots of complex tax reporting, and there was no issue of paying extra capital gains if the trade is ultimately successful.

Gold market and GLD volatility overview

In March 2019 FED was signaling a rate pause which could be bullish for gold prices. This is an example of using options to express a “long gold” opinion in a portfolio, in this case using the physical Gold precious metal ETF (GLD)

In March 2019 Gold volatility was approximately 9%, which was in the lower quartile (lowest 25%) for the last six months – having had a range of approximately 12% in Dec 2018, down to 8.5% in Feb 2019. Low volatility generally makes a better trade entry for long term calendar diagonal spreads. Importantly saying that “the volatility is cheap” only means relative to its own recent history in the last few months for this particular ETF or commodity. This does not mean that the underlying will not move around, because trading gold is historical volatile. This only means that the debit on trade entry is cheaper, simply as you don’t pay as much option time premium for the longer dated call (because the market is currently pricing less of an expected move by Sept 2019).
The chart below shows the GLD volatility chart for several months before and after trade entry on 22nd March 2019.

GLD July 2019 1 year volatility chart
trading gold - Long GLD Diagonal Calendar Spread - Volatility chart with Popup Balloon - 20190729

Trade Entry in March 2019

Having made a decision to long gold for 2019, the next step is to structure a suitable risk/reward trade within the 30 day rule. Here is the original trade entry when GLD closed at $123.97 on 22nd March 2019:

 
Trade Date
Category
Trans Type
Description
Symbol
Quantity
Price
Amount
22-Mar-2019
Portfolio
Sell to Open Short Call
Call GLD 128.00  EXP 17-May-2019
GLD190517C128
-6.0
0.77
$464.65

22-Mar-2019
Portfolio
Buy to Open Long Call
Call GLD 128.00  EXP 20-Sep-2019
GLD190920C128
6.0
2.70
-$1,622.29

TOTAL
$ 1157.64

 

This trade was OTM so had approximately a 30% of being ITM at expiration - it was therefore a lower probability trade, but high conviction portfolio position ("long gold for next 6 months"). Losing the entire trade premium (defined at trade entry) was acceptable risk for the overall portfolio - but the payoff was potentially large for the relatively small initial risk, so it created the right risk profile to express the trade idea. Initially selling the shorter dated call help finance the longer dated call, and reduce the overall risk in the position. The intent is to avoid this shorter call being assigned and roll it multiple times over the summer to gradually chip away at the premium paid for the longer dated call.

Here are the main high level scenarios for the trade outcome - GLD stays in a range, goes up a lot or goes down a lot (just about covered all scenarios in finance there!):

If gold stays the same or rallies slightly towards but not through the short call, it can likely be bought back for less than it was sold for - this helps to reduce the basis on the original longer dated option. If this can be done over a few months rolling option calls can nicely reduce the basis on the original longer dated option. Usually selling the 30 delta OTM call is a decent starting strategy initially, but once the position basis is reduced then selling calls that are more than 30 delta OTM is ok.

If gold rallies strongly in the next month, it maybe difficult to roll the short call at a profit. This is a risk of the calendar spread strategy - the market call is "right" but gold rallies too fast, and the position makes little money. This happens because the negative delta of the short call becomes similar to the positive delta of the longer dated call - so the overall position can become delta neutral or even negative delta (short underlying) in a strong rally. On average though the short call can be managed with month to month adjustments.

If gold tanks in the next month, it maybe difficult to roll the short call to get any reasonable premium in the same strike in the next month. However if any premium is available in the next month call, then it can be sold at the same strike. In the situation where gold goes down, one luxury of any calendar spread strategy is to simply sit on the trade and hope it comes back. This is "ok" as a strategy with calendar spreads because the limited risk was defined at order entry.

Trade Adjustment in May 2019

The trade adjustment that was chosen in the end, was to let short call expire worthless and simply hold the longer dated Sept 2019 call option. This has keeps the trade risk to approximately $1150 but there is still now no upside cap and still plenty of time for the trade thesis to play out. The trade is now $464 better off than if we had just bought the long dated call for $1622. Sometimes doing nothing can be the best option.

Option Skew in July 2019

As of 29th July, the Sept 2019 Option premiums are indicating that the market is pricing in significantly more upside than downside for gold in the next 7 weeks. Looking at the option chain below shows the distance of both 30 delta OTM put and call options from the underlying GLD price.
trading gold - Long GLD Diagonal Calendar Spread - Option Chain Skew Sept 2019 - 20190729

GLD is traded at $134.53 as of the NY close on 29th July 2019. Going 53 days to expiration on the Sept 2019 option chain, shows that the $139 call (with a delta of 0.2998) has approximately the same delta of the $132 put (with a delta of 0.2963). This means that market is assigning the 30% probability that GLD is $4.50 higher by Sept 20th 2019 expiration and a 30% probability that is $2.50 lower. That appears to be a huge bullish skew indicating that the market is still expecting higher prices in the medium term - despite the recent rally. If that bullish skew starts to disappear in the next few days, then would consider closing the long position, but for now content to hold until closer to expiration - especially because the option position only has a relatively small amount of remaining extrinsic value (time premium).

Specifically the extrinsic value (time premium) on our long dated call option is only approximately $0.65, with the majority being intrinsic value. Extrinsic value was calculated by adding the mean bid/ask for the option price ($7.175) to the option strike ($128), then subtracting the actual GLD market price ($134.53) = approximately $0.645.

Importantly this now means that the option delta is over 90%, so the position is trading like a stock position in the underlying. Since 6 calls $128 Sept 2019 are held, that representing a 6 x 100 x option delta = 600 shares x 0.9088 position = approximately equivalent to a 545 GLD share position. That represents a notional position of approximately 545 share equivalent x $134.53 = $73,318. There are some slippage in option bid/ask spreads and the option will move as GLD moves around - but that does give a good approximation of the current position size.

Trade Update in July 2019

This is the current GLD price as of 29th July 2019, and the position has made nice progress after the trade entry on 22nd March 2019:
trading gold - Long GLD Diagonal Calendar Spread - Price chart - 20190729

The current unrealised gain loss on the Sept 2019 call position $2727, added to the $454 from May 2019 expired call, gives a total gain for the overall position of approximately $3181. This is approximately a 276% return on capital so far.

These are some possible exit strategies as the option call is getting closer to Sept 20th 2019 expiration date:

Exit long dated call at a profit - simplest technique, but does not maintain any portfolio gold exposure which will likely be a good idea in a rate lowering environment. This can be done by either just simply selling the call, or by selling dated Sept 2018 ATM calls and hoping to deliberately get called away.

Roll long dated call up and out to a higher strike - this will depend if volatility is still high (over 10%) then this would be an expensive trade. Specifically because if the long option is significantly ITM and getting closer to expiration date (Sept 2019) - it will not have a lot of time premium left in it. Rolling the call up to several months out further out will likely incur some higher than desired premium (due to the high volatility environment). However rolling out could remove all risk from the position (if done for a $1150 credit) and would maintain a multi month GLD position into 2020.

Sell long date call, and switch to using "high volatility" strategy to maintain a long gold position - e.g. bull put spread

Summary of trading gold with long term diagonal spreads

In summary on 29th July the call option position represents an equivalent $73,318 long GLD position, that was acquired with about $1150 of risk. With this strategy there was initially a 30% chance of GLD finishing in the money above $128 by expiration (based on the option delta). The probability of a touch is defined as double the initial option delta - so that also means that over the trade lifecycle there is a approximately a 60% probability of GLD touching $128. To word that in a different way it means that at some point between Mar and Sept 2019 in all likelihood there will be about a 60% possibility of taking at least some profit from the trade. Additionally because we thought GLD would go up in 2019, then we also are thinking that the stated probability was under priced. That meant that using our bullish opinion on trading gold from the macro fundamentals has given us the opportunity to put the odds on our side.

Importantly this wasn't just like a lottery ticket style infomercial that says "I make 500% a week buying options" - where the stated returns are often from buying lottery ticket way OTM options that only make that "big" money occasionally, but on average is a losing option strategy. In summary the GLD strategy had:

  • a defined theoretical probability in advance
  • limited risk/reward
  • time for the investment idea to play out

This trade shows the power of option leverage, and why it is always a good idea to structure your portfolio to respect it - even if we just happen to be on the right side of it this time. This trade is still ongoing so no decision has been made yet, however it shows how to get to good risk adjusted returns using a relatively small amount of capital.