Tuesday, May 24, 2011


When St. Louis Federal Reserve President James Bullard speaks, Wall Street listens. Here are the headlines:

* Bullard Says FOMC Likely to Go on Pause After QE2 Ends in June
* Bullard Says Fed May Tighten Even With Unemployment High
* Bullard Says He Believes 1st Qtr Growth May Be Revised Up
* Bullard Says Europe Not Now a Global Macroeconomic Shock
* Bullard Says 'Imperative' for Congress to Fix Debt, Deficit
* Bullard Says 'We Are in Sustainable Recovery at This Point'

Run, don't walk, to read Barry Ritholtz's 'On Investing: The Many Hats of Great Investors' in The Washington Post.

The two-year U.S. note auction was strong "thanks" to the renewed safety trade evident in the marketplace now. The yield was .560%, which is slightly better than expected. Bid to cover at 3.48 (about 0.10 better than the previous few auctions) and the percentage of indirect bidders at 31%.

Who is the large gold call option buyer -- and what does it mean?

Over the course of the past few months, one large buyer has accumulated approximately 50,000 gold call option contracts -- most of the calls are strikes between $1,600 and $1,800 an ounce and for expirations between August and December. In total, as much as $50 million in call premium has been paid out by the purchaser.

As the gold futures market is roughly 10x to 15x the size of the gold options market, this is a huge bet in absolute dollars relative to the liquidity of the market.

Considering that the calls are well out-of-the-money (gold, on a futures basis, today trades at $1,512), the call option is all premium and, as such, is a decaying asset. So, given the size of the purchase, the buyer is not likely an individual hedge fund -- more likely, it is a central bank or a sovereign fund.

It is interesting to note that all of the buyer's options mature after QE2, so the buyer might believe, for example, that the institution of QE3 holds a greater probability to be implemented than the consensus is currently forecasting.

The buyer is clearly betting on a large run-up in the price of gold during the summer and fall months.

With all this leverage in the hands of one owner, a sharp price appreciation in the price of gold could cause the shorts (on the other side of the call option trade) to continuously buy futures and further contribute to a rising gold price in order to maintain a flat delta.

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