Insight: Both bulls and bears drive gold options volatility

A participant walks past a poster at the Asian Financial Forum in Hong Kong January 20, 2010.

NEW YORK/CHICAGO (Reuters) - Fears of a global financial meltdown or a double-dip recession often send gold investors scurrying to put on bullish bets in the options market.

Over the past month, however, gold bulls have had new company: Traders who sought protection against a decline in bullion prices as they became increasingly fearful that a series of steep one- or two-day drops over the past month could lead to a deeper fall.

Gold options' implied volatility -- a measure of how much traders expect prices to move, either up or down, in the future -- has posted its strongest surge in over two years and is more than double its level of early July.

On the surface of it, no surprise: options volatility usually rises in tandem with real market volatility. However, more gold option traders are using puts to hedge against downside risks after the metal failed to extend gains beyond a record above $1,900 an ounce last week.

It was the second time in three weeks the market fell back from a new all-time high.

Open interest in bullish call options based on the SPDR Gold Trust -- the world's biggest bullion exchange-traded fund and referred to by traders as GLD -- rose to an all-time high as of Monday's open, up 78 percent since mid-July to 3.4 million contracts, said Henry Schwartz, president of Trade Alert.

During that same period, GLD put open interest -- existing positions that will pay off if gold prices fall -- climbed to nearly 2.8 million lots from 1.6 million.

"What is interesting is that both call and put open interest increased by about 78 percent over that period. But call open interest has led the put open interest, historically," Schwartz said.

The CBOE Gold ETF Volatility Index, which is often referred to as the "Gold VIX" and is based on GLD options, rallied for a fifth consecutive day to a two-year high at around 40, more than double the 15 posted in early July.

(Graphic: r.reuters.com/syb73s)

COMEX gold options open interest also rose to a record near 1.4 million contracts as of Friday, the latest exchange data showed.

DOWNSIDE RISK SEEN

Spot gold gained as much as 13 percent in the past 12 sessions due to renewed fears that Greece will default on its debt and a gloomy U.S. job outlook.

A series of extraordinary volatility spikes combined with sharp price declines since mid-August have caused some to question gold's near-term outlook.

Investors are particularly worried about gold's erratic safe-haven bid, with bullion sometimes falling in sync with riskier assets and sometimes rising against them.

Growing fears of a Greek default hit the global equity markets and the euro on Monday as investor confidence in the European currency area's ability to overcome a sovereign debt crisis faded.

Analysts said the risk to short-term gold prices is to the downside as the rise in bullion has lagged that of gold option volatility.

"Gold investors should be especially cautious at this time because the heightened volatility will only exacerbate the severity of any correction that does take place," said Gareth Feighery, a founder of options education firm MarketTamer.com.

On the other hand, increased bullish bets in GLD options by prominent U.S. hedge funds also contributed to elevated gold price volatility, traders said.

Eric Mindich's Eton Park Capital raised its stake in the GLD call options to 8.7 million shares from 6 million shares at the end of the second quarter.

COMEX floor traders said that a sharp rise in the CBOE Volatility Index also prompted cross-asset investors to buy gold options.

The VIX, also known as the Wall Street fear gauge, jumped almost 10 percent to over 40 on Monday, spawned by worries Moody's Investors Service would downgrade French banks and by the lack of a solution to Greece's debt problem.

"I think that we are going to make a very big move very soon, and it's to the upside," said COMEX gold options floor trader Jonathan Jossen. He expects the price of gold could rise to $2,100 an ounce in the next two weeks.

(Reporting by Frank Tang)