US stock market strength has investors in a year-end pickle. The rally run to new ALL TIME HIGHS last week in the Big Three: S&P 500, DOW, and Nasdaq equity indexes has flipped the reward to risk payoff.
The uptrend remains on track with few exhibiting patience for a pullback. FOMO buyers, fear of missing out, and a lack of short sellers have made this a one direction market…for now.
The broad market S&P is up 10% in 2016, with much of it in the last month and a half.
The combination of a relief rally after the election, a return to corporate earnings growth, and the energy stock recovery on $50 Crude Oil all contributed to newfound confidence in corporate America.
A lack of any profit unwinding is dangerous for those buying in after this six-week boom.
Other global measures have been pressured by slowing growth concerns.
China has been stuck sideways with President-Elect Trump threatening tariffs or even a trade war.
The reality is that 10% of the Chinese GDP comes from exports and America accounts for 20% of that number. Even a reduced GDP growth rate in China of 6.5% is still the envy of industrialized economies.
The iShares China ETF was actually outperforming the S&P for the year in October before the latest stock buying burst.
The FXI iShares China ETF stands unchanged for 2016 compared to the surging US stock market. The five-year FXI range from $32 to $48 has the midpoint resistance at $40, more than 10% above current trade.
A crisis crush saw a 50% fall in 2015, but that was AFTER a rally to the highest Chinese stock levels since 2008.
Action has remained range-bound between $36 and $38 over the last year and five months. A rally to the channel top technically targets a $2 measured move to $40.
This is an opportunity to use the power of options for a capital-preserving stock substitution strategy.
The June option has six months for Bullish development.
An In-The-Money option gives you the right to be long with the shares from a lower strike price and it costs much less than the ETF share itself.
The Options Way: Unlimited Upside Potential with Limited Risk.
An iShares China ETF long call option can provide the staying power in a potentially larger trend extension. More importantly, the maximum risk is the premium paid.
One major advantage of using long options instead of buying or selling shares is putting up much less money to control 100 shares — that’s the power of leverage.
Choosing an option can sometimes be a daunting task with all of the choices and expiration months. Simply put, traders want to buy a high-probability option that has enough time to be right.
The option strike price is the level at which you have the right to buy without any obligation to do so. In reality, you rarely convert the option into shares. Simply sell the option you bought to exit the trade for a gain or loss.
There are two rules options traders need to follow to be successful.
Rule One: Choose an option with 70%-plus probability. The Delta is a measurement of how well the option reacts to movement in the underlying security. It is also important to buy options that give a payoff from only a modest price move.
There is no need to ONLY make money on the all but infrequent long shot price explosions.
Good Options can profit from just modest directional moves.
Any trade has a fifty/fifty chance of success. Buying In The Money options increases that probability. That Delta also approximates the odds that the option will be In The Money at expiration.
Buying better options are more expensive, but they are worth it — the chances of success are mathematically superior to buying cheap, long shot, Out Of The Money lottery tickets that rarely ever pay off.
With FXI trading at $35.50, for example, an In The Money $32 strike option currently has $3.50 in real or intrinsic value. The remainder of any premium is the time value of the option.
Rule Two: Buy more time until expiration than you may need — at least three to six months for the trade to develop. Time is an investor’s greatest asset when you have completely limited the exposure risks.
Traders often buy too little time for the trade to develop. Nothing is more frustrating than being right but only after the option has expired premature to the market move.
Trade Setup: I recommend the FXI June $32 Call at $4.25 or less.
A close in the stock below $32 on a weekly basis would trigger an exit. Notice the $32 strike has the right to be long from a discounted level that marked the June low.
An option play also has staying power with the ability to ride through Ups and Downs that would force most stock traders out of the position.
The option also behaves much like the underlying stock with much less money tied up in the investment. The Delta of this $32 strike is 80%.
The June option has six months of time for bullish development.
The maximum loss is limited to the $425 or less paid per option contract with an exit stop loss at half the option premium to reduce dollar exposure. The upside, on the other hand, is unlimited.
The FXI option trade break even is $36.25 at expiration ($32 strike plus $4.25 or less option premium). That is just 75 cents above the current ETF price.
A push above $38 channel top resistance targets $40 which would put the option value at $8.00 to nearly double the original investment.
– Alan Knuckman
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Source: Investors Alley