Gold Options are similar to gold futures except they don't carry the same risk. Options give the buyer the right to control 100 ounces of the precious metal, but, if the market moves against the contract, the most the speculator will lose is his premium. When the market moves against a futures contract, things can get really ugly fast. The speculator can be on the hook for much more than what he paid to purchase the contract in the first place.
For example, lets suppose that you bought a futures contract on gold that has a 90 days left on it before it expires. The market price at the point of purchase is $800 per ounce. Your contract gives you the right to buy/sell gold for $800 an ounce. The market goes against you with 80 days left in the contract and now gold is selling for $750 per ounce. Fifty dollars below your contract.
In this situation, your futures broker would call you and ask you to put more money into your account which is now short 100 ounces x $50 = $500.00. If you refuse, he will sell out your position and you are still obligated to come up with the $500.00. Should you again refuse, he will go to court, get a judgment, and start the collections process.
Things get even nastier as your credit is negatively affected, your paycheck gets garnished and you end up with a lien on your house. You are no longer welcome in any futures brokerage and you wish you never got involved in the futures market. People have literally lost fortunes playing the futures market.
Now, lets pretend you own an option with the same control over 100 ounces of gold. The market goes against you just like in the above scenario. You can ride it out because the most you have to lose is the premium you paid for the option in the first place. If the gold price doesn't go any higher, you've lost that anyway. Now you can sleep at night.
In the futures market, you can put a “stop loss” order that forces your broker to sell into the market, but, you still have to cover whatever your losses were before the stop-loss order is executed. Things could still get crazy. Permit me to illustrate:
You buy a contract for $800. You also tell your broker to sell your contract if gold prices go lower than $798 per ounce. You're still on the hook for the $2 per ounce difference (100 bucks), but you consider this an acceptable risk. This is called a “stop-loss” provision/order and is designed to stop you from losing your shirt. 10 days in gold plunges $50 per ounce. As its falling, your broker is trying to sell your contract into the market. He finally finds a buyer when gold hits $795 per ounce. You guessed it, your liability just got a whole lot greater.
Now the real heart-breaker. Gold recovers after you sold your contract and actually goes up to $820 per ounce. Not only have you lost the profit ($20 per ounce x 100 ounces = $2000); you still owe your brokerage $500.
If you had bought an option instead. You could have waited out the bad and benefited from the positive move in price. Much less risk and far greater potential for a reasonable profit. Options make a whole lot more sense than futures contracts to the conservative investor. You get the same contract (100 ounces of gold), with the same leverage, with the same upside for profit.
What you don't get, is the sleepless nights and constant worry a futures contract can bring.
These are some of the sayings from gold expert Paul A Drockton M.A.
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