Gold option commentary_october_2010

October 2010

Steve Ellis

Consultant to Baker Steel Capital Managers LLP

Gold Options Commentary

Gold Options Chartbook and Commentary

Option Strategies to Maximise Risk Adjusted Returns

October 2010 2

Steve Ellis

Consultant to Baker Steel Capital Managers LLP Gold Options Commentary

Gold Price Volatility (Realised Vs Implied)

Key Takeaway: Volatility is low and options have become inexpensive

October 2010 3

Steve Ellis


Implied Gold Volatility (Vs G10 Currency Volatility)

Key Takeaway: Gold options cheap compared to other vol markets based on historical levels

October 2010 4

Steve Ellis


Term Structure of Implied Vol’s – Now versus 1 month prior

Key Takeaway: Short dated options are substantially better value than long dated

1w

2w

3w

1M

2M

3M

4M

6M

9M

1Y

18M

2Y

3Y

October 2010 5

Steve Ellis


Skew of Implied Vol’s – Implied Volatility for Equivalent Calls Vs Puts

Key Takeaway: Investors over-confident particularly in “longer term”

1w

2w 3w

1M

2M

3M

4M

6M

9M

1Y

18M

2Y

3Y

October 2010 6

Steve Ellis


Rough Sketch of Favoured Strategy

Key Takeaway: Buy short dated Puts; Sell longer dated Calls

5P

10P

15P

20P

25P

30P

35P

40P

45P

atm 45C

40C

35C

30C

25C

20C

15C

10C

5C

October 2010 7

Steve Ellis


Recommended Hedge Strategy Section

Key Assumptions:

Base Portfolio is Long 100% Junior Gold Equities

Hedging Risk Budget = 5% p.a.

Max Notional on Aggregate Short Options = 10%

Gold and Gold Junior Equities experience distinct volatility but they correlate directionally at +1.0

Upside/Downside (U/D) Target is 2:1

Gold Juniors 1 month ATM Implied Vol. 33% (9.5% per month)

Gold Prices 1 month ATM Implied Vol. 18% (5.2% per month)

October 2010 8

Steve Ellis



Scenario 1: Base Juniors Portfolio Up and Down 2 Standard Deviations Best Upside/Downside = 1.1 (Gold Juniors)

Hedge Notional (Delta Adjusted) at Best U/D ratio: N/A

Cost of Best U/D ratio: N/A

October 2010 9

Steve Ellis



Scenario 2: ATM, 95% Strike and 90% Strike Gold Puts (6 months) Best Upside/Downside = 1.19:1 (90% 6m Puts)

Hedge Notional (Delta Adjusted) at Best U/D ratio: -61%

Cost of Best U/D ratio: 2% (4% p.a.) out of 5% budget thus max hedgeable = 125%

October 2010 10

Steve Ellis



Scenario 3: ATM, 95% Strike and 90% Strike Gold Puts (3 months) Best Upside/Downside = 1.50:1 (90% 3m Puts)


Cost of Best U/D ratio: 0.5% (2% p.a.) out of 5% budget thus max hedgeable = 250%

October 2010 11

Steve Ellis



Scenario 4: 90% 3m Puts + (Sell 110% 12m Calls to buy 95% 1m Puts ) Best Upside/Downside = 1.80:1 (90% 3m Puts) + (Sell 110% 12m Calls) to buy (12 consecutive 95% 1m Puts)


Cost of Best U/D ratio: 0.5% (2% p.a.) thus max hedgeable = 250% (90% Puts) + 33% (95% 1m Puts)

RBSGF 1 Month Returns: +/- 0.5,1.0,1.5,2.0 Std Deviations

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

-20% -15% -10% -5% 0% 5% 10% 15% 20%

Junior Gold Miners

Unhedged Prefered Portfolio

-2.0 -1.0-1.5 -0.5

October 2010 12

Steve Ellis


Conclusion

Scenario 4 has the best Upside/Downside ratio (1.80:1) of the strategies examined.

Buy purchasing short dated puts and selling longer dated calls in takes maximum advantage of both Term Structure (page 4) and Skew (Page 5)

Purchasing the (90% 3m Puts) protects against a sustained fall in gold prices over a decent period of time

By selling (Sell 110% 12m Calls) to buy (12 consecutive 95% 1m Puts) additional “gap risk” is provided for at all times. Each month 33% notional protection can be secured (below 95%) in return for giving up 10% upside (beyond the 110% strike)

With a combined Hedge Notional (Delta Adjusted) of -155% at 2 standard deviations below today’s levels the protection offers enough exposure to cope with Gold Junior’s higher Beta versus Gold Prices

Ceteris Paribus (for option pricing, term structure and skew) the structures could simply be repeated at expiry

Any significant inflows or redemptions could be added/subtracted on an as needs basis

October 2010 13

Steve Ellis


IMPORTANT

This document is issued by Baker Steel Capital Managers LLP, a limited liability partnership registered in England No. OC301191, which is regulated by the Financial Services Authority. This document refers to Genus UCITS Gold Fund (the “Fund”), which is an unrecognised collective investment scheme for the purposes of the Financial Services and Markets Act 2000 of the United Kingdom (the “Act”) and whose promotion is accordingly restricted by law.

This document is being issued inside and outside the United Kingdom to and/or directed at persons who are both (a) professional clients or eligible counterparties for the purposes of the FSA Conduct of Business Sourcebook (“COBS”) and (b) of a kind to whom the Fund may lawfully be promoted by a person authorised under the Act and The Financial Services and Markets Act 2000 (Promotion of Collective Investment Schemes) (Exemptions) Order 2001 including other authorised persons, certain persons having professional experience of participating in unrecognised collective investment schemes, high net worth companies, high net worth unincorporated associations or partnerships, the trustees of high value trusts and certified sophisticated investors.

This document is exempt from the scheme promotion restriction in Section 238 of the Act on the communication of invitations or inducements to participate in unrecognised collective investment schemes on the grounds that it is being issued only to the types of person referred to above. No offer to sell (or solicitation of an offer to buy) will be made in any jurisdiction in which such offer or solicitation would be unlawful.

The information and opinions contained in this document are for background purposes only and do not purport to be full or complete. This document does not in any way purport to give investment advice. No reliance may be placed for any purpose on the information contained in this document or their accuracy or completeness. No representation, warranty or undertaking, express or implied, is given as to the accuracy or completeness of the information or opinions contained in this document by any of Baker Steel Capital Managers LLP or the Fund and no liability is accepted by such persons for the accuracy or completeness of any such information or opinions. Past performance is no guarantee as to future performance.

This document does not constitute or form part of any offer to issue or sell, or any solicitation of any offer to subscribe or purchase, any shares or any other interests nor shall it or the fact of its distribution form the basis of, or be relied on in connection with, any contract therefor. Recipients of this document who intend to apply for shares or interests in the Fund are reminded that any such application may be made solely on the basis of the information and opinions contained in the prospectus or other offering document relating thereto, which may be different from the information and opinions contained in this document.

© Baker Steel September 2010 (third party sources acknowledged)

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Gold option commentary_october_2010