While geopolitical events continue to create market anxiety, gold prices are unlikely to surge higher according to the options market. In fact, gold options volatility, reflected by the CBOE’s gold implied volatility index GVZ, is nearing a 7-year low, which was last hit, in mid-March. Current levels reflect market complacency. While it appears that gold prices are sliding sideways waiting for the next impetus to drive them higher or lower, the decline in implied volatility ahead of the French and British elections in May and June respectively reflect that gold option traders believe the status quo is the likely outcome.
Just as a refresher, implied volatility is the markets estimate of how far a security will move over the course of a year on an annualized basis. Implied volatility is the key component used by option traders to determine the value of an option, based on the likelihood that gold prices will be at a specific level at some point in the future. An implied volatility level of 11.5%, means that option traders believe that prices will not move more than 11.5% from the current levels, either higher or lower, during the next 12-months.
The low levels of implied volatility tell us that any surprise could lead to a surge in gold prices, but the status quo will keep prices capped. The decline in options premiums has been driven by declining gold implied volatility, which has set the gold market up for a potential short squeeze if the market is surprised.
Surprises that could shock the market is a victory for French Presidential Candidate Marine Le Pen. Traders would likely scramble to purchase safe-haven assets if Le Pen was victorious, and gold implied volatility would surge as option traders scramble to cover themselves.
Another political event is the snap general election that was called for by British Prime Minister Teressa May. If she loses the election, which appears to be a referendum on quickly starting the Brexit process, the pound could soar, and this unexpected event could also drive up gold prices.
North Korea continues to taunt the West, and no one should be surprised if Donald Trump has an itchy trigger finger. While the consensus is that Trump will use China to help corral North Korea, his bravado is huge, and he is likely to show some form of aggression to let the American people that he is President that nobody can mess will.
Trump has already flip flopped on NAFTA, which has generated choppy market conditions for the Canadian dollar and the Mexican Peso. Just this week, Trump’s administration told reporters that the President was considering withdrawing from NAFTA which was a campaign promise. Later in the week, Trump told the American people that he had two very good conversations with both the President of Mexico and the Prime Minister of Canada and decided not to pull out of NAFTA.
Trump is full of surprises and what is currently priced into gold options is that there will be no surprises as implied volatility hits multi-year lows. A rush to cover options could lift gold prices to 2017 highs, especially if the markets is caught off guard.
Originally published here: Are Gold Traders Too Complacent?