IAUM - Gold Volatility Rises As Expectations Change

2023-11-03 21:25:00 ET

Summary

• Before a recent price surge on the heels of the Israel/Hamas conflict, rising Treasury yields helped spark a decline in gold prices.
• Gold has been moving in almost perfect sync to the dollar, only in the opposite direction.
• These factors have contributed to rising volatility and trading volume in CME Group gold options.

By Scott Bauer

At a glance

• Options traders expectations shifted to upside risk following the Middle East conflict.
• According to the CME Group Volatility Index (CVOL), the concern for an extreme move in gold reached its highest point in over a year in early October.

Before a recent price surge on the heels of the Israel/Hamas conflict, rising Treasury yields helped spark a decline in gold prices.

Yields have continued to rise because investors are finally starting to believe the Federal Reserve's determination to keep rates higher for longer.

The U.S. Treasury is also being forced to issue massive amounts of new paper into a market where traditional buyers are reducing their purchases.

Additionally, gold has been moving in almost perfect sync to the dollar, only in the opposite direction. These factors have contributed to rising volatility and trading volume in CME Group gold options.

Bearish Trend

Gold's outlook, fortunately or unfortunately, typically has much to do with the underlying interest rate environment.

Higher rates raise the opportunity cost of holding gold, which is priced in dollars and does not yield any interest. But, gold is also known to be a hedge in times of uncertainty and during the possibility of heightened geopolitical risk.

Just prior to the escalation of the Israel/Hamas war, gold reached its lowest settlement since March, and was headed toward potential further declines, with its short-term moving average nearly falling below its longer-term moving average.

The futures and options market reflected this bearish sentiment through the CME Group Volatility Index or CVOL. CVOL is unique in that it applies a simple formula using out-of-the-money put and call options prices in highly liquid markets to produce a single view of risk expectations for the next 30 days.

CVOL also measures "skew," which is the difference in volatility between at-the-money ((ATM)) options, in-the-money options, and out-of-the-money (OTM) options. Skew serves as an indication of the direction of volatility relative to upside or downside price risk.

We can see from the chart below that prior to the Middle East conflict, the skew in gold options heavily favored OTM puts. In fact, the skew was at its most negative in over a year.

But that changed quickly as geopolitical risks heightened, as can be seen in the following graph.

CVOL also measures convexity which is used to measure a portfolio's exposure to market risk. Convexity is a measure of the ratio of the volatility level of the OTM strikes to that of the ATM, meaning how expensive are the "extreme move" options. When levels become elevated, traders may be looking for an extreme move.

The below chart shows that the concern for an extreme move in gold reached its highest point in over a year in early October.

As global economic uncertainty persists, understanding the impact of events on gold volatility can help investors and traders more effectively manage the risk of sudden market moves.

Original Post

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