A Breakdown of GVZ

On April 12th, the GVZ finally began trading. While it has not come running out of the gate with huge volume, my hope is that eventually the product will take off. I simply feel it is too good of a product to not do so. There are too many traders involved in Gold for this not to drum up some interest. I thought traders might be interested in a breakdown of how the options appear to have been priced.

The Futures:

Like the VIX, GVZ futures (a bet on the forward value of GLD volatility) appear to be in contango the majority of the time. For those unfamiliar with contango it is a phenomenon where a back month future is trading at a higher price than a front month future. In the S&P 500 futures this exists when interest rates are at higher levels. In VIX and GVZ contango exist because the perception of volatility in the future is greater than the current volatility in the market place. If the VIX is a fear gauge then one way to put contango would be: we are more afraid of more distant future than the immediate future. 

Unlike the VIX, the contango in GVZ futures does not appear to be nearly as strong as contango in VIX futures. Today, for instance, May VIX future is trading at about a 3 point premium to cash. GVZ is only trading at a premium of about 1.20. The months following are around 1 point higher successively.

The Options:

The options opened with an IV around 65% in the front month. Relative to historical volatility, this is a touch higher than the trailing historical volatility of GVZ cash at just about every measure of distance: 10, 20, 30 or 60 days. However, since this is based on movement in the futures, NOT the cash, I expect HV will be much lower in the GVZ futures as volume increases. 

Like VIX, the term structure is such that implied volatility in back- month options is lower than implied volatility in front month option. This is also likely due to perceived realized volatility in back month forward volatility (say that 5 times fast). Essentially, since the back month futures are not going to be seeing as much movement, there is little reason for these options to have as high of an implied volatility as the front month.

Like VIX the GVZ has a forward skew or commodity skew. This is because of its perceived use, the market maker in the product is assuming that traders are afraid of volatility going up in gold and thus will try to hedge against a rally in GVZ. Traders that use GVZ to hedge will be buying calls and selling puts to collar rather than the traditional collar where one would buy puts and sell calls.

While the volume is light, traders are going to have to ‘work’ orders if they want to get any type of decent execution. With that in mind when the options opened I bought a May 16 call to see how tough it would be to get a fill. The market makers filled me at less than .10 above the mid price, not bad for a brand new product.

My initial perception of the product is that for retail traders looking to play GLD volatility, it will likely make more sense to play at the money (ATM) options rather  than out of the money(OTM), for now.. It appears that OTM options are a touch “over priced” in general. This leads me to want to sell call spreads, buy butterflies, and when bearish, buy puts out right rather than try to sell a call credit spread. 

Before entering in any type of GVZ option trade I would strongly suggest that traders read the white paper, what the options trade, and maybe even paper trade a touch. I would also warn traders that like VIX many broker platforms are pricing the options off of the cash instead of the futures, thus any IV you are looking at is essentially worthless.

For those interested in learning to hedge GLD against GVZ in the same way many traders use the VIX as a hedge against S&P 500 trade I will be writing about this subject frequently on my blog.

For more information about GVZ, please visit www.cboe.com/GVZ