Growing support (both on and off the charts) for Chinese stocks mean that it’s time for traders to take a second look at the space — preferably via the iShares China Large Cap ETF (FXI).
Back on July 8, this strategist penned a bullish article that made the case for dipping one’s toes into the large-cap Chinese stock space using FXI and its options to position.
Due to the extreme short-term technical situation in FXI and Chinese stocks at the time, as well as a mostly worried collective investor attitude regarding China’s central bank actions, we took a shorter-term, in-and-out approach. And we ended up seeing a quick double on our long call trade.
Now, investor sentiment is much more supportive and hopeful regarding Chinese central bank actions, Chinese stocks are sporting more attractive long-term valuations and the charts are supporting a deeper and more durable bottom.
It’s time to look a the big picture!
FXI Monthly Chart
Click to Enlarge
FXI has provided a monthly candlestick tests and bullish reversal off a pair of channel line supports, as well as a key 62% retracement level dating back to the late 2008 bottom.
Charts and the support lines aren’t foolproof, of course, but the deep discounting of FXI and Chinese stocks over the past few months does appear to offer a solid risk-reward situation for bullish investors seeking a longer-term position.
The one caveat with this overall bullish picture isn’t pundits in the background shouting about a bear market. Rather, this strategist is weary of FXI’s fairly extreme move in excess of 10% over these last couple trading sessions.
FXI’s price spike higher is expected to see a bit of backing and filling this week to digest its gains and work off a short-term, overbought condition.
As we don’t believe a pullback will be so severe as to break last week’s lows in FXI, a little patience on any forthcoming price weakness is suggested.
FXI Long Call Option Strategy
With shares trading up more than 1% to $36.52 as of this writing, we like the Jan $40 call priced at $1.20 mid-market.
The January contract looks attractive as it gives the trader a decent amount of time for FXI to solidify and build on the potential bottom.
At the same time, if we anticipate a retracement of about 50% from last Friday’s low, FXI would be trading at $35, or about 4% lower.
As a move toward $35 relates to the FXI Jan $40 call, with initial directional risk of about 33 cents for every $1 move in FXI, we’re able to roughly estimate what we’d pay for the call if shares of FXI do pull back.
Given a drop of $1.50 in FXI to $35, we can expect the call price to decline by about 50 cents — that’s $1.50 x 0.33 (directional risk/delta).
As our pricing for the FXI call is simplistic and doesn’t account for the impact of the contract’s other Greeks, a drop of 40 to 45 cents with the call priced for 75 cents to 80 cents is more realistic, rather than a slightly cheaper 70 cents ($1.20 – 50 cents).
Bearing this in mind, a trader could place a good-till-canceled limit order for 75 cents in the FXI Jan $40 call.
This strategy allows the trader to buy on weakness if FXI moves as anticipated — and at the end of the day, position more wisely given the short-term and longer-term view.
Investment accounts under Christopher Tyler’s management do not currently own positions in any of the securities or their derivatives mentioned in this article. The information offered is based upon Christopher Tyler’s observations and strictly intended for educational purposes only; the use of which is the responsibility of the individual. For additional market insights and related musings, follow Chris on Twitter @Options_CAT.
