Gold Options Flash Crash?

That's right, it kind of happened. But ask people who trade gold options, and they might not even know about it. That's because you didn't see the entire market collapse, but one strike in particular did. Here's what happened.

Yesterday was March Gold options expiration. An hour or so after the open, gold was trading 1775. The March 1775 calls were worth approximately $5.50 (11 dollar straddle). This strike started to go in size in one lots. As I looked at the prints on my screen I immediately knew something was wrong. On the same strike, with nothing changed, I saw successive prints trade 5 dollars and then trade 10 cents. A minute of staring at my screen later, I realized I was seeing what I thought I was. How is this possible?

It isn't rocket science. If you put in an order in enough size without a limit on it, you will sweep the market until you take out all of the bids. If there aren't sufficient bids to accommodate a market sweep order, then a bid at say..... 10 cents, will get hit. And that is likely exactly what happened. Now how is it possible that 10 cent prints were going in literally the same second (though not at the exact same time) as 5 dollar prints? Machines will quote both sides of the market, lets say 4 tics wide. If these quotes refresh every half second, and the sweep order is offering every quarter second, there might be no legitimate bids outstanding. Some people leave resting tic bids out there, just in case such a scenario takes place. When there is a seller at market, and the only bid is at 10 cents (1 tic) that's where they'll trade. 

Remind you of how Proctor and Gamble was down 37% in a matter of minutes on no news? The flash crash was not due to anything mystical, but rather a lack of buying interest and stop market orders getting triggered. While noticed by few, gold options march 1775 calls were just another example of how readily such an event can take place.

Gold Rips to end an otherwise quiet day; Gold setttle 1771.3

All seemed rather quiet on the Western front. Gold was pushing up against the 58 level, hovering in a tight range. And then, Boom! We ripped through the day's high of 1761.7, and through resistance at 1767. While we settled 1771.3, we went on to make a high of 1783.4. I had commented in the past that while 1763 and 1767 seemed to be the numbers in everyone's sights, that 1750 was really the important level. Yesterday's break through and settle above may have been the re-emergence of a bull market in gold.

While we can talk about technical levels all we want, the far more important story is gold's performance in light of that of other asset classes. Yesterday, after it became clear that the European weapon of choice to deal with Greece was bailout, and not default, one would expect the equity markets to rally. They didn't. But gold took off, up over 30 dollars at its peak. And today, when gold began its rally, The S&Ps were down 5 handles. When gold was 22 dollars higher, the S&Ps were 2 handles higher.

As we began rallying, I scrambled to see if there was any news. But there wasn't. As anyone who watches gold will tell you, these moves (QE and Fed minutes aside) are usually less news driven, and more a product of something we're probably all unaware of. One could make the compelling academic argument that a Greek bailout is the nail in the coffin for fiat money maintaining its value over the next few years. But I won't bother. While I believe everyone who "waits for pullbacks" will be kicking themselves in a year or two, the fundamental reason behind the story matters less. Someone is buying gold, and there is just too much short term momentum for short sellers to stomach the risk. Don't think because we've rallied that we are out of steam. This bull still has a long way to run.

Go home flat into the long weekend; Gold circa 1723

As we close the week out, we are essentially unchanged from where we were when I wrote on Tuesday. I had said that I favored being short. We pushed higher towards 1740, and then made lows near 1706. Each time it looked like we might break out or break down we came back to this area where we now sit. Options are getting sold as we seem to be stuck for the time being. But while my bias is and likely for some time will be to the upside, I would go home flat, and be careful to pick my spots in the upcoming week.

Reasoning? The markets are reacting to Greek headlines. Right when it seemed like we were poised to break down to 1700 and every CNBC contributor was warning of imminent market doom, Greece started making promises. And we, and by we I mean equities and commodities rallied. While 2012 has been a nice headline-light grind higher, seeing markets react to Greek headlines concerns me. In 2011 on average hedge funds, the so called "smart money" under-performed the indices by approximately 6-7%. I attribute this to a number of things, but I mention it to point out just how hard it became to trade in such a headline driven market. Do you remember how headline driven 2011 went? The most brilliantly constructed position could turn bad on the drop of a dime, or a meaningless promise by a soon to be obsolete Greek politician. Then a "high ranking German finance minister" or someone with a similar title would say something that stirred markets, only to never be addressed again. And to top it all off, we had a number of situations where the pundits reported news that moved markets, only to later have to admit that the story they broke was untrue. Some market.

I hope that we will soon again put Greece on the back-burners so that the market can resume its steady climb higher. But for now, the risk of trading from either the long or short side, when we are seeing evidence that headline risk is re-emerging is simply a losing battle. Come next week, we may find that the market is no longer reacting to headlines, in which case I'd say dive right back in (and of course be long). But smart investors know that sometimes the best position to have is no position at all, and I think that is the prudent move now.

Have a Great Extended Weekend.

Ben

End of Day Greek Love

Today proved to be an interesting day on the futures side of theings. We have been trading in very tight ranges over the last few days. This morning, as I looked up at the futures at 6:30 am, we were trading 1719.4. I went away for an hour and came back and what were we trading? That’s right, 1719.4. But those who got lulled to sleep by the sluggish action were in for an interesting day. A sell-off began shortly after the open taking gold to lows of 1713.8, and options got bid (puts in the front months were the most bid). At that point one might expect to see choppy trading throughout the day, but I was taken by surprise at the speed at which we rallied. When we recovered to 1719 (where we had stalled) I expected to see consolidation (trading in a tight range). Instead we ripped, and in a matter of minutes, we made the day’s high of 1729.9. As the day went on we crept lower until selling off before the options close, and settling, near where the morning started (at 1717). As I write at 4:15 eastern, gold is trading at 1723.2. While we have bounced around both sides of the range, gold looks poised to drop from here. We have had trouble getting above the 1734 level, which should serve as resistance for now. Any move higher should run into resistance at 1750, which we have been unable to breach and hold.


As i wrote this, Greece made another promise; and like the girl that just keeps falling for "the wrong guy" commodities and equities rallied off of their lows. I still favor getting short here, but if we start to see the market caring about Greek headlines again, I would run to the sidelines, as trading on anything sensible becomes a near impossibility.

Commentary of stop fishing algos; 2/8/12 gold settle 1731.3

It is rare that something that seems so clear cut and obvious works multiple times. This morning was one of those times in gold where the trade just seems so obvious, you begin to wonder if you have really keyed into something that everybody is missing. The previously discussed 1742 level looked to still be in play. Following yesterday's struggle to trade or settle above 1750 (we traded above it but the action was pretty weak) we seemed sure to return to that 1742 level. It turned out to be a great buy, and it got you 8 dollars up to the 1750 area. I then looked for gold to consolidate above 1750 and build a base before trending higher. This however was not to be.

Gold began to sell off making multiple intra-day lows. It made a low of 34.4, then 31.4 and then finally bottomed out at 1726. As we slowly crept up to the 28 level, gold picked up momentum and traded quickly up to 31. The algorithms, which were likely looking to trigger stops had little luck in the 26-28 area as the volume at these levels was very low. Certain types of algorithms look to trigger stops (sell stops in this case) by selling gold down into areas where these stops are deemed to be. As a for instance: If gold is trading 1701 and 1700 is considered a big support level; algorithms will begin selling, trying to push gold down to say 1698. Traders who felt that 1700 is a level of support might put their stops in at 1699. This is a practical way to trade; put a stop in below a point of support (if you are long, above resistance if you are short) as a way to limit risk. But this is no secret. Algorithms know where the levels of support and resistance are, and will push it through levels to trigger these stops. The algorithm that sells gold down from 1701 to 1699 is rewarded if there are a large number of stops in this area, because they will trigger sell orders pushing the market down further. After those stops are triggered, the algos can buy back their shorts.

Lessons? The first is, the worst place to put a stop is a tic above or below a known point of support or resistance. Far too often, with such a tight margin for error their will be a brief violation of that support or resistance, causing you to get stopped out at the dead lows of a move (assuming your long). It is thus important to give a little breathing room below critical levels so that you don't get taken by the algos.  The second takeaway that I could see today was how to use volume as an indication of whether their is a potentially profitable short term trade. As mentioned, when gold made its new low, it moved lower on very light volume. Seeing this is a tip off that there were no stops at these levels to be triggered, and as a result, the algo selling would stop. While I can't speak to how these algos all operate, it would stand to reason that they would actually have to buy back the futures they had shorted in an effort to get momentum moving to the downside. If you are quick enough to notice that this is taking place, you could get long a few futures, ride them up for a few points, and make a quick hit. Around 1728 was clearly the spot to do this today, and it was good for a quick 3-4 dollars.

I will likely not write tomorrow as I am going to a conference to try to learn a little bit about high frequency/ algo trading. Hopefully I will be able to come back with some insights. In the meantime, keep a close eye out for Friday at 12:30 when Big Ben speaks. Recently his comments seem to act like speed for the markets. Depending on the trend, it might be a good time to put on a long gold position circa 12:15 pm. We will see if the experiment works.

Best,

Ben

Don't invest with Bud Light

http://www.youtube.com/watch?v=Eo1BHwPtQcc

"We dreamed of turning gold into platinum", says Bud Light in their Superbowl commercial last night. While the general consensus among viewers was that commercials were pretty lame last night, I am still pretty surprised that while paying millions for a 30 second spot, Bud Light would not have done a little bit more research. Why? Because anyone who would like to do a 1 for 1 swap, selling platinum and buying gold is giving up nearly $100 per ounce right now. Don't get me wrong, I get the general marketing concept; beer has a golden coloration, and to do the double comparison, color and value seems pretty creative..... And it would be, if it wasn't simply wrong.

Courtesy of Kitco, I have included below the 1 year Charts for both Gold and Platinum. As you can see, it is not as if this difference in price is a completely new phenomenon; though it is true that historically platinum has traded at a premium to gold. I have yet to see anyone with a Bud Light trading jacket on the floor of the Comex, but perhaps they were the same ones selling the June 4000 puts 2 dollars under intrinsic. While I can say I have gotten the occasional free beer or key chain from Budweiser, I never did expect they would be so willing to literally give away money.

Can you say Election year? (Gold trading circa 1740... but coming off)

It has been about 2 weeks since my last post, and Punxatawney Phil's prediction that winter will persist hardly made it any easier to muster up the motivation to write something on this Friday afternoon. The gold option pit is quiet, and while it feels like we have done nothing but go up, today's 20 dollar sell off actually leaves us nearly unchanged on the week. The stock market has continued melting up, and today popped big in response to a far better than expected employment report. Let's not get into labor force size, or the fact that the Challenger jobs report was -50k for January... or the fact that no economists on the street were even close to this number. Because really, who cares. Lets just remember, its an election year, and we are sure to have plenty of treats served to us in the form of economic data.

If it were 1998, and a brilliant oracle came to you and said that there would be an enormous bubble in tech forthcoming a year or two away, what would you do. Would you wait until that bubble came to get short? Hopefully, you would do the intelligent thing and buy immediately, not wanting to miss the run-up to the bubble's eventual popping. Following a great January, we could choose to take our profits and rest on our laurels, but we know that in this election year, we will get more numbers like this. Whether it is real or not is inconsequential. With equity fund flows still at historically depressed levels, there is more money around to chase this rally. Soon mom and pop retail will hear about this American recovery story and jump on the bandwagon. Then, we can start talking about taking some of these longs off.

This morning's action was a real head-scratcher from a gold perspective. One would expect the employment numbers to be good for both gold and equities, as they have been trading more or less correlated. Why the breakdown? There was no serious technical failure (1763 was a big number which we did breach overnight following yesterdays failure to breakout past it), that would cause such a strong sell off, and fundamentally, nothing has changed. Talking to people on the floor, the best answer I heard was that the algorithms probably find equities relatively more attractive and sell commodities to finance the purchase of stocks. I continue to believe that the slow grind higher will continue, and that today's divergence between gold and stocks will be a one off scenario. I would like to have my money in equities over gold for the short term, but the risk (as we are now trading 1730 in gold) for both continues to be to the upside.

If there is one place I wouldn't want my money, it is on either side of the Superbowl line. The two teams match up well and the game is a real toss up. If the Pats are to win, their ability to drive quickly down the field means that they could win by 14 in a close game. In other words, the protection the Giants are getting with a two or three points is not the same kind of protection you were getting betting the Giants in the San Francisco game. The line on the over/under has moved down to 54.5. As counter intuitive as it might seem, I like the under. It is true that the Pats can put up points quickly, and their defense can give them up quickly. Still, I think Coughlin will look to establish the run, which should not be tough against the Pats D. If this is the case, longer drives for the Giants will help keep the score lower. If nothing else, seeing Pats fans happy makes me unhappy, so this Jets fan is rooting big for big blue. Go Giants!