Today, January 10th 2011, the GLD ETF is trading at 133.80 and one can buy the January 2012 call with a strike of 120 for $19.75.
That means: It's possible to purchase a position in GLD with a down payment of 14.76%. This amounts to the total risk taken. The balance of $114.05 is "financed" at a rate of 5.22% per year. To arrive at this yield, I divided the option premium paid by the balance that would remain if I purchased GLD at 133.80 and applied the option premium as a down payment.
$133.80 - $19.75 = $114.05 = financed balance
$5.95 = total premium paid divided by $114.05 results in 5.22%
If this position would be held to expiration, an increase in the price of GLD of 4.45% or more would yield a profit. The income generated from investing the $114.05 cash balance would be added to that profit.
The real advantage of this strategy reveals itself when the price, against expectations, falls. For instance, if the price of gold should go down by 20% in 6 months, to about $1100 an ounce from the current 1375, and GLD therefore falls to $107, the strike 120 call with 6 months to run should still cost about $3.50.
Selling it at that price would result in a loss of $16.25, but the loss on the GLD itself would have been $26.80.
Now we would have the opportunity to employ the same strategy at the lower price.
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