High on low gold volatility.

High on low gold volatility Futures markets which trend slowly for long periods of time often disappoint the futures options traders who have bullish or bearish opinions.

An option buyer who identifies the trend direction correctly can still lose on the trade.

Profitable options

strategies require assessments of market volatility as well as direction. Markets with very low volatility are generally unprofitable for someone who simply buys puts or calls. However, low volatility markets can provide excellent opportunities for those willing to put on option spreads involving several strikes.

Various strategies can be employed based on the trader's assessment of the probability of different outcomes. These assessments should reflect historical correlation between the price of the underlying futures contract and the volatility of that futures.

Gold futures provide a good illustration. Gold futures prices and the volatility of futures prices are positively correlated -- that is, gold price movements are more volatile when the price is high than low. For this reason, the precious metal is very volatile in bull markets and much less so in bear markets.

Gold prices can drop sharply in a short period of time. However, this usually occurs only right after a sharp upward movement.

Gold price volatility declines significantly once prices have been in a bear trend for a year or so. Further declines consists of slow drifts rather than sharp drops.

But rallies can be explosive. Gold can move up strongly and quickly after staging a bear or trendless market for a long time.

The bear market in gold has lasted about a year and a half. Someone who expects this trend to continue may not want to be short futures or even buy put options because of the prospect of a sharp rally. Instead, you may want to buy a slightly out-of-the-money put option and sell put options in each of the two strikes below that strike. This is usually done for about "even."

To use closing Commodity Exchange Inc. prices on Aug. 4, for example, you could buy a December 370 put for $830, sell a 360 put for $500, and sell a 350 put for $290.

This requires a net outlay of $40 (plus transaction costs) but gives you a maximum profit of $960 if December gold futures are between $350 and $360 per oz. at the options' expiration. There will be some profit if futures are anywhere between $340.40 and $369.60 per oz.

If the bear market in gold futures ends abruptly, the trader loses $40.

The big risk in this strategy is that losses can be unlimited if prices plunge below $340.40 per oz.

Assuming such a position means the trader believes history is a useful guide to the future -- that is to say, gold bear markets will continue to exhibit little volatility.

John L . McCormack is president of Minerals Market Research, a Chicago-based analysis and trading firm.