FxWirePro: PBoC’s rising gold reserves keeps eyeing on tight hedging – delta combos to mitigate downside risks

After achieving a new nine-week's high of $1,112.89 per troy ounce in early trading this morning, gold subsequently dipped back below the $1,100 mark.

This marked the end - at least for the time being - of a four-day phase of rising prices which saw gold gain by $50.

As per Chinese central bank's figure, China topped up its gold reserves in December for the sixth consecutive month.

The data show that the PBoC bought around 610,000 ounces or 19 tons of gold last month. This is remarkable given that the PBoC's currency reserves declined by more than $100 billion in the same month.

By year's end, official gold reserves thus amounted to some 1,762 tons. This still equates to only around 1.8% of China's currency reserves, however, so we expect the PBoC to continue expanding its gold reserves in the new year.

On the contrary, gold futures for February delivery were down 0.71% at $1,099.90 on the Comex division of the New York Mercantile Exchange.

Hedging Frameworks:

Skeptic bulls can adopt the below strategy with a view to hedge a long position in the underlying outrights by holding longs on protective put.

Thereby, any declines in this commodity would be taken care by ITM put options since the holder of the put option will have right to sell at predetermined strike price at expiry in case of American style options.

Puzzle is that which instrument to be selected to make it suitable for trend..? Well the hedger takes following positions constructs this strategy:

A higher (absolute) Delta value is desirable for an option buyer, whilst a Delta close to zero is desirable for the option seller; a buyer wants their option to become more valuable whilst a seller wants the option to become less valuable.

So, write 4D (1%) OTM call option + go long in an (1%) ITM +0.59 delta put option with 1M expiry (both near month contracts). Writing OTM calls may likely to fetch certain returns since any abrupt slumps in near future may be taken care by this instrument.