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- 1. Volatility Research & Trading Research@vVolatility.com 04 November 2009 Volume 1, Issue 4 Gold: Elliott Wave and Volatility Point to a Top Contracting Triangle We appear to be on the 5th wave of the triangle thrust, and just $19 from the projected top. The necessary ingredients for a contracting triangle are Another target for the terminus of the triangle thrust (and five contracting waves (labeled A-B-C-D-E), each containing most 5-wave sequence) is provided by parallel trendlines; one three sub-waves (labeled a-b-c). that connect the bottoms of waves 2 and 4 and one that touches the top of wave 3. This projection points to the same After the contracting triangle completes and a breakout target as the triangle thrust. takes place, the high probability expectations are; A final point on 5 wave sequences: the 3rd (middle) wave 1) a “thrust” equal to the widest point of the triangle, cannot be the shortest of the impulse waves. In the chart be- measured from the terminus of wave A (Gold $1,104) low, wave 1 is $93.60 in length (930.60 to 1024.2). Wave 3 is 2) five waves in the thrust. $85.60 in length ($985.20 to $1070.80). Therefore, wave 5, which started at $1026.75, cannot be longer than $85.60. If 3) Once the five waves have formed, and the thrust tar- spot gold exceeds $1112.30, then this analysis falls apart, and get reached, expect a quick move back to the apex of the something else is at work. triangle (Gold $955). Finally, it may seem preposterous suggesting a top in gold 4) Sentiment is a key factor in the thrust (there should be after India just scooped 8% of yearly global production, but this waning speculation) and implied volatility and skew will be is exclusively a look at Elliott wave and sentiment as indicated the best indications of this. We should see falling implied by volatility, and nothing to do with fundamentals or headline volatility and less call skew as the upward thrust completes. flows. 1120 1100 Gold 5 1080 Triangle thrust projection: 11 A move measured from the triangle breakout that 3 b 1060 is equal in distance to the widest part of the 1040 triangle (measured from the terminus of wave A). a 1b c 1020 4 1000 B 9 c a 980 D c b c 2 b 960 a b 940 a 920 a a b c 7 E 900 c a C 880 b 860 c A 840 5 Jan-09 Feb-09 Apr-09 May-09 Jul-09 Aug-09 Sep-09 Nov-09
- 2. Implied Volatility is unimpressed with higher Gold The break of the triangle 1120 5 was initially met with excite- 1100 Gold ment, renewed gold fever and 1080 3 11 a spectacularly fast jump in b 1060 one-month implied volatility 1040 1 a from 16% to 26%. Implied 1020 B b c 4 volatility was cheap and had 1000 c a 9 been relatively motionless for D c 980 b c 2 the previous two months, so a b 960 a move of that extent was not b 940 a entirely unexpected. 920 a a b c 7 E What did seem a bit odd, 900 c a C was the speed with which 1m 880 b vol fell back to 17% once the 860 c A spot advance paused. 840 5 Jan-09 Feb-09 Apr-09 May-09 Jul-09 Aug-09 Sep-09 Nov-09 On the next jump in gold (wave 3 on the top chart), im- 1120 45 plied volatility rose again, but was unable to surmount the 1100 43 wave 1 high. 1080 41 The current gold rise has 1060 39 produced an even more pa- 1040 37 thetic volatility response. 1m 1020 35 vol is languishing below 19%, a full 7% less than it attained 1000 33 after the initial triangle break. 1y Implied Vol 980 31 One-year implied vol is also 960 29 unable to exceed recent highs 940 27 as gold propels higher. 1y vol 920 25 has been overvalued by at least 10% for a long time now, 900 23 1m Implied Vol so the muted vol response is 880 21 less of a surprise than the 1 860 19 month stupor. 840 17 The lower chart shows 1m 820 15 and 1y 25 delta risk reversals Jan-09 Feb-09 Apr-09 May-09 Jul-09 Aug-09 Sep-09 Nov-09 (25d call vol - 25d put vol). The 1m RR managed to reach 1120 12 3.5% on the wave 1 and 3 ad- vances, but has dropped below 1100 11 2% on the current gold rise. 1y 25d Risk Reversal 1080 10 This is a clear example of a lack of participation by the 1060 9 speculative community. 1040 8 The 1y RR is more reflec- tive of real (long-term) gold 1020 7 demand, and is at silly levels to 1000 6 begin with. With implied vol falling as gold rallies, the RR 980 5 should be on a fast track to 960 4 zero. 1m 25d Risk Reversal 940 3 There must be a level where both specs and long- 920 2 term security seekers re-enter the market via gold calls, but 900 1 that level is likely significantly 880 0 higher (beyond the triangle Jan-09 Feb-09 Apr-09 May-09 Jul-09 Aug-09 Sep-09 Nov-09 thrust projection top?). Volume 1, Issue 4 Page 2
- 3. One-year Implied Volatility is expensive; One-month vol is fair. The premium of one-year implied volatility 1120 46 over one-year realized volatility remains 1100 extreme. (realized vol is exponentially 44 1080 weighted using hourly data). 42 1y Implied vol 1060 1040 40 has been consis- tently overvalued 1020 38 since Dec 08. 1000 36 It fell 20% from 980 the March 09 44% 960 34 top, but has further 940 32 to go. 920 900 Gold 30 Who buys this stuff at a negative 28 880 edge of 10% to 860 26 15%? 840 24 At some point I 820 1 yr Implied Vol would expect a 22 degree of capitula- 800 10.9% 20 tion from the 1y vol 780 buyers. 760 1 yr Realized Vol 18 740 16 720 700 14 680 12 Oct-08 Dec-08 Jan-09 Mar-09 Apr-09 May-09 Jul-09 Aug-09 Sep-09 While one-year implied vol is extremely expensive, one-month 60 1m Implied vol implied vol is fairly valued. The recent jumps in 1m vol were displays the volatile 1080 58 unsupported by realized volatility, but any move back to 16-17% nature of specula- 56 1055 tors. appears to offer reasonably-priced gamma for the next gold move. 54 1030 52 While realized 50 vol was first stead- 1005 ily lower, and then 980 Gold 48 consistently side- 46 ways, the jumpi- 955 44 ness of implied vol 42 930 shows the desire of 40 specs to hop on 905 38 breakouts. 36 880 At these levels, 34 1m vol is a safe buy 855 32 when it trades at or 30 830 below weighted 1m Implied Vol 28 realized vol. 805 26 780 24 22 755 20 730 18 16 705 14 1m Realized Vol 680 12 Oct-08 Dec-08 Jan-09 Mar-09 Apr-09 May-09 Jul-09 Aug-09 Sep-09 Page 3 Volatility Research & Trading
- 4. Limited Loss Trades to play a top at $1,100 and a dip to $955 Trade Ideas: affected by skew) costs 10% of payout. Odds are therefore Implied Vol is reasonable in the front end of the curve and 9:1. For every $10 you bet, $100 is received if $955 touches. rich in the back end, so any strategy should incorporate either front end purchases, back end sales, or both. Trade 3: Buy a 1.5 month ATM straddle Skew is extreme for calls in the one year, so that favours selling low delta calls and buying low delta puts. But since the absolute level of 1y vol is high, we are left with just 1y call An idea with much less leverage, but a greater chance of selling. turning a profit is a simple purchase of an at-the-money straddle, again for the 18 Dec 09 date. With implied volatility Skew is moderate for the one-month, so buying puts is at 20.5%, an atm straddle costs $57. Breakeven is $57 either reasonable (they are cheaper than calls. Avoid selling gamma side of spot, so if our $955 target comes to pass the profit (Gold calls), since we want to make a bit of money if correct (on expiration) would be 1.55 times premium. If India has in our analysis, not lose our jobs if wrong. several more tones of gold to buy, or if all fiat currencies sud- One month is a bit too short, and two months is too long, denly disappear, the topside profit potential could also be so we’ll settle on 18 Dec (46 days) for option expiries. attractive. Trade 1: Buy a 1.5 month 30 delta put Trade 4: Buy a 1y Gold call with a $1,300 RKO (for the With Gold at 1,100, and 46 day 30 delta puts at 20% vol, tempered bulls). the cost of buying an 18 Dec 09 $1,065 Put would be $14.70. Our target is $955 (triangle apex), so if correct we would To sell both high 1y skew and high 1y implied volatility, a make a net gain of $95.30, or 6.5 times premium. If wrong, 1y $1,100 Gold call (off a spot of $1,100) with a reverse we would lose $14.70. knockout at $1,300 costs a mere $10. The premium rises to Trade 2: Buy a 1.5 month $955 one-touch $20 if the knockout is pushed higher to $1,400. The risk in these trades is a Gold rises beyond the topside barrier. You would lose the premium despite calling the direction cor- A $955 one-touch (American style—look any time) also rectly. based off a $1,100 spot and 19.5% vol (lower than the previ- ous trade because it is a lower delta and is therefore more Ma nag e th eD own sid e... Please direct any enquiries or feedback to: Research@vVolatility.com Page 4 Volatility Research & Trading Disclaimer: This document researches assets from primarily a volatility perspective. No forecasts made or implied in this analysis should be used as a basis for assuming, increasing or reducing risk of any sort. The opinions expressed in this publication are those of the author, and are subject to frequent and dramatic change as new information is introduced. This document is for entertainment purposes only.

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