London - The rally in gold may be reined in by options selling sometime in the next four to six months, if hedge funds and other institutional investors begin to view the rally as overstretched, some market observers said this week.

Options in Comex gold and the over-the-counter market are predicting the precious metal has a 25% chance of being above $1,400 per troy ounce by the end of 2010, even though few market participants will make such bullish predictions, said JP Morgan managing director Neil Clift.

At this week’s annual London Bullion Market Association conference in Edinburgh, a poll of audience members found the average forecast for gold’s price in September 2010 was $1,181 an ounce. On Friday at 1626 GMT, spot gold was trading at $1,092 an ounce, up 24% this year but 28% below the $1,400 an ounce level.

The disparity between the high prices predicted by options and much lower consensus price forecasts could be an opportunity for investors to sell gold options, which could trigger a significant correction in gold prices within the next six months, Clift said.

“I’m in the bullish camp. At the moment the market is in bullish mode and I actually am probably more a bull than most,” Clift said. “[But] at some point we’ll see people coming in to sell options. There is potential value to be had in selling away the topside. It may be a long time before that happens. But at some point it will.”

Gold rallied to a record high this week on news that the Reserve Bank of India bought 200 metric tons from the International Monetary Fund. The purchase appeared to confirm predictions that central banks were losing confidence in the dollar and wanted to increase and maintain their gold holdings.

Gold’s dramatic ascent since July, without any significant correction, may tempt some longs worried about a short-term correction to sell options to protect their gains.

A gold call option is a bet by the buyer that prices will rise to a specific price. The buyer gets the right but not the obligation to buy gold at a specific price, but has to pay a premium for this, which is collected by sellers. The seller is betting against prices rising that high. If it does, he has to pay the price to the buyer, or deliver the equivalent in gold–though this rarely happens. If not, his profit is the premium. The opposite of this is a put option, where the buyer bets prices will fall and the seller is less bearish.

More Details: Click here