Gold Miner's Recovery Could Result in Nearly 200% Profits by 2015

The price of gold has declined below the weekly pivot at $1,300 an ounce, presenting a potentially lucrative buying opportunity. The two-week, nearly $100 drop in the metal is about half of the recent run up from the double-bottom lows.

Despite the recent decline, SPDR Gold Shares (NYSE: GLD) is up nearly 7% as the first quarter comes to a close. However, over the past 52 weeks, GLD is down 28%. And as you can see in the chart below, miner Barrick Gold (NYSE: ABX) has been hit even harder, off 38%. 

GLD vs ABX Stock Chart

On July 5, ABX made an extreme low at $13.43, but this low was not accompanied by new highs in volatility. This bullish divergence suggests a long-term bottom was put in place.

Sideways trading action between $22 and $14 since April has midpoint support at $18 to lean on.
The $8 channel targets $30 on an upside breakout above $22 resistance. 

ABX Stock Chart

The $30 target is about 68% higher than recent prices, but traders who use a capital-preserving, stock substitution strategy could make nearly 200% returns on a move to that level.

One major advantage of using a long call option rather than buying a stock outright is putting up much less capital to control 100 shares -- that's the power of leverage. But with all of the potential strike and expiration combinations, choosing an option can be a daunting task.

You want to buy a high-probability option that has enough time to be right, so there are two rules traders should follow:

Rule One: Choose a call option with a delta of 70 or above.

An option's strike price is the level at which the options buyer has the right to purchase the underlying stock or ETF without any obligation to do so. (In reality, you rarely convert the option into shares, but rather simply sell back the option you bought to exit the trade for a gain or loss.)  

It is important to buy options that pay off from a modest price move in the underlying stock or ETF rather than those that only make money on the infrequent price explosion. In-the-money options are more expensive, but they're worth it, as your chances of success are mathematically superior to buying cheap, out-of-the-money options that rarely pay off.

The options Greek delta approximates the odds that an option will be in the money at expiration. It is a measurement of how well an option follows the movement in the underlying security. You can find an option's delta using an options calculator, such as the one offered by the CBOE.  

With ABX trading near $17.85 at the time of this writing, an in-the-money $13 strike call option currently has about $4.85 in real or intrinsic value. The remainder of the premium is the time value of the option. And this call option currently has a delta of about 87.

Rule Two: Buy more time until expiration than you may need -- at least three to six months -- for the trade to develop.

Time is an investor's greatest asset when you have completely limited the exposure risks. Traders often do not buy enough time for the trade to achieve profitable results. Nothing is more frustrating than being right about a move only after the option has expired.

With these rules in mind, I would recommend the ABX Jan 2015 13 Calls at $5.75 or less. 

ABX Call Option

The strike price is below the July low of $13.43, which is the lowest level seen since 2000. A close below $14 in ABX on a weekly basis or the loss of half of the option's premium would trigger an exit. If you do not use a stop, the maximum loss is still limited to the $575 or less paid per option contract. The upside, on the other hand, is unlimited. And the January options give the bull trend more than nine months to develop.

This trade breaks even at $18.75 ($13 strike plus $5.75 options premium). That is only about $1 away from ABX's recent price. If shares hit the $30 target, then the call option would have $17 of intrinsic value and deliver a gain of nearly 200%.

Recommended Trade Setup:

-- Buy ABX Jan 2015 13 Calls at $5.75 or less
-- Set stop-loss at $2.87
-- Set initial price target at $17 for a potential 196% gain in 9.5 months

Note: Most online options brokerage accounts have an advanced feature that lets you take and keep money lost in the stock market, essentially claiming it before Wall Street brokers get their hands on it. Here's how you could use it to get away with $1,200 or more today.

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