Stay long Feb'17 CME gold Following the December Fed hike, macro markets broadly reacted meaningfully to the more hawkish rate projection, with gold specifically selling off to $1,213/oz.  This price level for gold made us take pause.

Granted, there are risks that the bottom in price could be similar to that reached in 2015 if real yields raise another 50 basis points; however, some of the assumptions one has to make to get us there look farfetched. 

We concluded that gold’s near-term selloff may be approaching an end given the severity in the post-hike moves in both the USD and S&P 500 and the magnitude of the sharp rise in yields. 

While the potential for a further near-term boost in yields and the possibility for further ETF liquidation pose near-term risks, we recommended going long the Feb'17 CME gold contract.

Initiate longs in CME gold for February delivery at a price of $1,191.50/oz on December 16, 2016. Trade target is $1,240/oz with a stop at $1,075/oz.

Alternatively, option trade plans are also devised as follows:

OTC outlook:

The current implied volatility of XAU/USD ATM 1w contracts are at 13% with skews signifying hedgers interests are in well balanced on either sides but slightly biased towards OTM call strikes, and it is likely to spike higher for 1m tenors.

While delta risk reversals substantiate these figures with upside risk sentiments (observe positive shifts across different tenors). By this we mean guaranteed hedge at the higher strike (worse than the outright forward rate if unleveraged) in order to benefit from a favorable market move down to the lower strike.

Hedging Strategy: Option straps (XAU/USD)

As the risk reversal numbers allow for a customized hedging solution, tailored to your risk and hedging profile contemplating both side risks. Risk Reversals are OTC derivative instruments and the notional amount does not need to be tied up throughout the full tenor of the trade.

Nonetheless, usual margin requirements still apply. Usually, Risk Reversals are structured as zero premium hedging solutions.

Hence, we recommend deploying hedging strategies to arrest upside risks with longs positions in 2 lots of 0.51 delta ATM calls with 1M expiry and 1 lot of -0.49 delta ATM puts of 2w expiries.

Subsequently, this XAUUSD option straps strategy would take care of ongoing upswings and abrupt downswings and yields handsome returns.