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With the New Year comes new trading opportunities. In this article I will give you some specific ideas for some limited risk trades for the next few months. I will give you the ideas behind the trades, outline the specific parameters for the trades, spell out the risks, potential rewards, and give you the current margin requirements.

GOLD

If you cannot view the Gold chart, go here.

Gold has been on an incredible run the last year. The low point for gold over the last few years was seen on October 24, 2008 when the price bottomed at $681 per ounce. From that point until the first week of December, 2009 gold rallied fairly consistently to an all time high of $1,226. This increase in the value of gold of $545 represents a bullish move of approximately 80% in just a little over 13 months. In the 2 months since, the high gold has backed off $120 or 10% to its current level of $1,106 per ounce.

The trade I am going to recommend today is known as a synthetic long call. This trade combines buying and selling options and futures to create a trade with limited risk and a lot of profit potential. First, though, you need to know that the gold contract consists of 100 ounces of gold. Therefore, a move of $10 in gold is worth $1,000 and an option that costs 10 points is worth $1,000.

Specifics of the Trade:

Long 1 June gold future at 1106
Buy 1 June gold 1105 put for $55 ($5,500)
Sell 1 June gold 1225 gold call for $25 ($2,000)
Margin requirement for the trade: $2,100
Expiration date: May 25, 2010
Maximum risk: $3,600
Profit Potential: $8,400 **

All prices and margins are based on the close of business on February 1, 2010.

The Trade Broken Down:

Risk

What we are creating here is a bullish gold position with limited downside risk. By going long the futures contract and essentially purchasing an at the money put, we are limiting our risk to the cost of the put which is $5,500 plus the amount that the put is out of the money, 1,106 - 1,105 = $1 or $100. By selling the 1225 call and collecting $2,000 we are lessening the maximum risk to $3,600. At the same time, though, by selling the 1225 call we are also limiting our upside profit potential on this trade.

Potential Profit

The maximum profit, if it is never adjusted, is $8,400**. This would be achieved if, on expiration, the price of gold is back to $1,225 or higher. If the price of gold is $1,225 on expiration, the futures contract will be profitable by $11,900** while the options will expire worthless for a loss of $3,500. The profit potential is limited because above $1,225 the profit on the futures will be offset by the loss on the 1,225 call, thus capping the potential for increased profit.

Flexibility

By combining futures with options in the position described above the trader has the ability to be flexible over the approximate 4-month life of this trade. In the last few weeks the price of gold has fallen approximately $40. If it should turn around and rally strongly over the next few weeks one could close the futures and the short call for a significant profit and hold onto the put option. If the market then falls back you could sell the put at a better price or reestablish the futures contract for another potential rally. This could be done a few times during the life of the options if the opportunity arises, making for exciting returns.

If the price of gold falls after entering the trade, the short 1200 call should start to lose value. At some point you could buy back that call for a profit and wait to see what happens. By buying back the call and staying in the long futures and put, the trade has unlimited profit potential to the upside. If gold then rallies back to the previous highs or higher the trade could become a real bonanza. At the same time, if gold rallies you could reestablish the short call and collect more premium to offset the cost of the initially purchased put.

Additional flexibility and also profit potential can be added to the downside of gold by purchasing additional put options. The 1,105 put is fairly expensive, currently, with a cost of $5,500. Instead of purchasing another 1,105 put one could buy an extra put below the market for less money. For instance, a 1,000 put could currently be purchased for approximately $1,800. Buying this extra put would take away from the upside profit potential, but if the price of gold falls precipitously over the next few months you could make some nice money on the downside with this extra put.

S&P500

If you cannot view the S&P500 chart, go here.

My Fast Break articles would not be complete if I did not include a recommendation for selling credit spreads on the S&P500. If you have followed my articles in the past you have seen that almost every single one expired worthless for a profit. There is no guarantee that the spreads I will recommend below will be successful but I like their prospects.

It looks like the rally off the lows from last March has finally stalled for a while. Since reaching a high around 1150 on January 19th we have sold off approximately 5.5% to our current level of 1086. This recent fall has pushed the volatility much higher (the VIX is back up near 23 after bottoming around 17) and put some premium back into the options. I think it is a great time to sell some June call and put spreads since we have the ability to sell the calls way above the recent high and at the same time we can sell the puts at the 900 level. I do not think we will sell off down to there any time soon. Below are the parameters of the call and put spreads for June that I would sell today.

Current level of the S&P: 1086

Sell June 1200/1230 call spreads for 4.7 points or $1,175
Sell June 900/860 put spreads for 3.7 points or $925
Total premium: $2,100
Margin requirement: $2,500
Maximum risk: $7,900 on the downside, $5,400 on the upside
Potential return on initial margin: 84%
Expiration date: June 18, 2010

All prices and margins are based on the close of business on February 1, 2010**.

EURO

If you cannot view the Euro chart, go here.

In a similar manner to the S&P500, the Euro rallied fairly steadily from a low of approximately 125 at the beginning of March, 2009 to a high of over 150 this past December. Since that time, though, the Euro has weakened to its current level of 139.2. Europe has a lot of problems and many of them are worse than ours. For instance, Eurozone countries have taken on record amounts of debt so far this year. I think the Euro will have trouble strengthening vs. the US dollar over the next few months and therefore I am recommending selling Euro call spreads.

Current level of the Euro: 1.392

Sell April 144/148 Euro call spreads for 57 tics (57 x $12.50 = $712.50)
Margin requirement: $820
Maximum risk: $4,287.5
Potential return on initial margin: 86%
Expiration date: April 9, 2010

All prices and margins are based on the close of business on February 1, 2010**.

**NOT INCLUDING COMMISSIONS AND FEES.

Mr. Jonathan Lubow graduated from Dartmouth College in 1989 with a BA in History. He has had uninterrupted registration with the National Futures Association since 1990. Prior to co-forming Trader's Edge in 1998, he was the number one broker for his firm for five straight years. At Trader's Edge, a commodity brokerage firm in New Jersey, he maintains the position of vice-president while still trading and servicing customer accounts. Jon is also a contributor to the OptionsScholar web site.

Mr. Lubow is married with two daughters and resides in Morris County, New Jersey.

Get 2 Weeks of Moore's Research Seasonal Trades!

Moore's Research Center Inc. and Trader's Edge have teamed up to present you with two complimentary weeks of proprietary futures research. Get trading strategies, charts, correlation studies, statistical analysis, and more! Sign up for your complimentary research now!