Tuesday, July 27, 2010

While GDX Fundamentals Decay - Time Decay Saves the Day

Fundamentals count!

In fact one of our top rules (#2 to be exact) states: "Only trade options on stocks that you have qualified through fundamental analysis." Today the fundamentals for GDX took a turn for the worst. What a difference a day makes! I post this months trade last night and the next morning while commuting to work I hear on a talk radio show that new EPA government regulations came out (oh great what this time) many of which negatively effect the gold mining industry.

Apparently the news or rather the uncertainty of it caused GDX to drop from $48.89 to $46.82 (low) closing at $47.09 per share. Down 3.7% for the day on heavy volume.

This means that until all of the hub-bub of what the new regulation means to the bottom line of the gold mining industry; GDX breaks rule #2 and is no longer fundamentally qualified as a trade candidate. Oh yeah it happens. This is why with all of the unknown policies to yet be defined "by regulators" within the recent health care and financial regulation bills passed by congress I don't have any health care or financial companies in my watch list. Our rules help prevent unnecessary risk and keep us on track to only use the best trade candidates.

GDX held at the recent $47 support level and is still well above our $44 Put strike price. It could very well stay above $44 on August 20th; however, the risk of the unknown could also drive GDX well below our strike price. With our #2 rule now breached we must exit the trade to protect our capital and move on to qualified trades that meet our rules.

Now here's the good news! The option income system still made money; whereas, buying stock we would have lost money. If we had purchased stock in GDX at the time when I entered and exited my option trades the GDX stock trades would have looked like this:

July 19 - Buy $47.10
July 27 - Sell $46.97
Not a big loss (13 cents per share) or $130 on 10 option contracts

Compare that to selling cash-secured Put options:
July 19 - Sell-to-Open $0.83
July 27 - Buy-to-Close $0.56
A gain of 27 cents per share or $270 on 10 option contracts

During the 8 days that we owned the contracts the time decay value of options was working for us and allowed us to buy back our option at a lower price than we sold it. This turned a potential $130 loss into a $270 gain!

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