Jeff Augen Trading

[mks212 0]

I have read 3 of Jeff's books recently and find them very informative. However, I find some of it to be very hard to put into practice and also some of it to be very backwards looking. One very notable exception is the volatility trades that we do here prior to earnings. That advice works out well and is applicable.

One example I'd like to understand is mentioned in two of his books, The Volatility Edge in Options Trading on page 253 and Microsoft Excel for Stock and Option Traders on page 21. The idea is comparing the ratio of GLD/XAU to the price of XAU. I have recreated the data and spreadsheets but can't figure out how to actually trade this info.

Can anyone shed some light? For example, using the first period (5/13/05-10/7/05) that shows a strong relationship, can you point out a potential trade? Jeff's argument is that because the R Squared between the ratio and the price of XAU is high during this time, it can be used to structure trades.

The spreadsheet can be downloaded here: https://docs.google.com/open?id=0B4xAKSwsHiEBQzJaWXZBR19uVEk. I tried to upload it to this post, however, the forum will not allow excel files to be uploaded directly.

Thanks.

[tjlocke99 18]

I have read 3 of Jeff's books recently and find them very informative. However, I find some of it to be very hard to put into practice and also some of it to be very backwards looking. One very notable exception is the volatility trades that we do here prior to earnings. That advice works out well and is applicable.

One example I'd like to understand is mentioned in two of his books, The Volatility Edge in Options Trading on page 253 and Microsoft Excel for Stock and Option Traders on page 21. The idea is comparing the ratio of GLD/XAU to the price of XAU. I have recreated the data and spreadsheets but can't figure out how to actually trade this info.

Can anyone shed some light? For example, using the first period (5/13/05-10/7/05) that shows a strong relationship, can you point out a potential trade? Jeff's argument is that because the R Squared between the ratio and the price of XAU is high during this time, it can be used to structure trades.

The spreadsheet can be downloaded here: https://docs.google....QzJaWXZBR19uVEk. I tried to upload it to this post, however, the forum will not allow excel files to be uploaded directly.

Thanks.

I share your opinion in your first paragraph.

As for the trade, you can trade XAU directly right? If you can't trade XAU then I don't know how you could structure any trade that wasn't completely speculative. For example if XAU and GLD are showing high correlation/cointegration and they diverge for a week let's say with GLD increasing at a greater rate then XAU, then you could buy an OTM GLD put and and OTM XAU call and hope for them to converge. HOWEVER, again without being able to trade XAU I'm not sure what you can do.

Let me know what you find.

[mks212 0]

As for the trade, you can trade XAU directly right?

Let's assume for the sake of argument that you can. I don't really know for sure, if I had to guess there are probably futures available on it.

To quote from the book:

"During the time frame [of the chart during] 5/2005–10/2005, intraday entry points for option trades could be identified as subtle deviations from the trend line. Intraday values above the line represented high-gold/low-XAU combinations, and points below the line represented low gold/ high-XAU (points displayed in the chart were calculated using closing values for the two ETFs). The time frames were also different with regard to the behavior of gold."

I am going through the data and cherry picked the point that was most above the trendline, 7/14/05, with XAU at $91.26 and GLD at $41.90. The GLD/XAU ratio was 0.46. The trendline indicated that XAU should have been at $94.50, so it was underpriced by $3.24. The trade I modeled was to short GLD and go long XAU. According to the trendline, XAU then became overvalued by $0.20 on 7/29/05. The short GLD/Long XAU trade could have been closed on that day for a profit of 2.7%.

I will look at a few other points on the line and also compile the trades in a spreadsheet a little bit later. I need to run at the moment but didn't want to take any longer to respond.

Edited December 4, 2012 by mks212