* Technical selling, dollar rally trigger profit-taking
* Volume hits highest since January after options expiry
* More put option strategies to lock in futures profits
* Coming up: U.S. weekly jobless claims Thursday (Recasts, adds comment, updates market activity)
By Frank Tang
NEW YORK, July 27 (Reuters) - Gold fell on Wednesday after hitting record highs on growing fears of a U.S. default, as technical weakness, a rallying dollar and a broad sell-off of riskier assets prompted bullion investors to take profits.
Gold volatility rose as trading volume hit its highest since January and marked the second-heaviest trading day of the year, after option investors exercised a large number of in-the-money $1,600 calls at Tuesday's option expiry.
In early trade, gold rose as the fate of Republican and Democratic deficit-reduction plans remained heavily in doubt as top lawmakers pursued a behind-the-scenes compromise to avert a crippling U.S. debt default. [ID:nN1E76P2HJ]
Bullion could pull back sharply if a deal to cut the U.S. deficit dampens market fears, analysts said. The metal is up about 9 percent in July on concerns over the euro zone debt crisis and uncertainty ahead of the Aug. 2 deadline to raise the $14.3 trillion U.S. debt ceiling.
"It was more of a technical failure combined with a dramatic bounce of the dollar," said David Meger, director of metals trading at Vision Financial Markets.
"The market is vulnerable to further retracement, and now it's just a matter to see if near-term support levels hold or we fail further from a technical perspective."
Spot gold
Silver
<^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^
Take a Look on gold hitting record high [ID:nL6E7ID1SS]
Gold correlation with dollar: http://r.reuters.com/ryx52s
Inflation-adjusted gold price: http://r.reuters.com/pun62s
Gold in different currencies: http://r.reuters.com/wun62s
^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^>
Meger said bullion prices were pressured by back-and-fill, retracement-type selling after the metal failed to rise further above the record high of $1,628.
OPTION VOLATILITY RISES
By 3:30 p.m. EDT, U.S. gold futures trading volume had topped 380,000 lots, the second-highest this year after the 2011 peak of about 410,000 lots set on Jan. 27.
The CBOE Gold ETF Volatility Index <.GVZ>, often referred
to as the "Gold VIX" and based on SPDR Gold Trust
Option traders said around 20,000 contracts of in-the-money calls with strike prices near $1,600 were exercised at Tuesday's option expiration.
More investors are using option strategies to lock in profits made in the underlying gold futures.
"The dealers are definitely buying puts and selling calls," COMEX gold options floor trader Jonathan Jossen said. "When you see these dealers are doing this ... they are looking for a move down or just locking in their risks."
Sharp losses in the U.S. equity markets and industrial commodities such as crude oil amid U.S. debt fears prompted investors to take profits in the gold market to cover losses elsewhere, analysts said.
Gold's safe-haven appeal fell after the president of Standard and Poor's, Deven Sharma, said the rating agency did not think the United States would default. [ID:nWEN6265]
A sharp dollar rally against the euro amid risk aversion also increased volatility and weighed down bullion prices. The euro came under pressure after Standard & Poor's cut Greece's sovereign credit rating further into junk territory.
Supply concerns underpinned gold as tens of thousands of South African gold miners will down tools on Thursday. South Africa is the world's fourth-largest gold producer.
Platinum
LAST/ NET PCT YTD
CLOSE CHG CHG CHG
US gold