The economic news from China and the United States lately has been less than stellar. With the exception of the labor numbers, few things are actually turning negative, but a slowing is starkly evident.
For example, we saw a major adjustment in U.S. GDP for the second quarter, which was revised down to 1.6% versus the original 2.4%. This was a big hit for the United States, but is equally problematic for China.
The risky co-dependant relationship between the two countries creates some opportunities we intend to take advantage of with a credit spread on the iShares FTSE/Xinhua China 25 Index ETF (NYSE: FXI).
Trade:
Sell to open the FXI September 38/39 call spread. This is an in-the-money credit spread with only 15 trading days before expiration, so we are expecting a move to the downside in the fairly short term.
Target Entry Price:
I would recommend this trade with a limit of 68 cents per share or better, which is a very favorable split of the bid/ask.
Exit Forecast:
The holding time period is very short, and if the market moves to the downside very quickly, we may exit within a week or two.
The short expiration is a double-edged sword, though, because although melting time value will help us, the spread is also in the money, which means the market needs to move below $38 in order for us to keep the maximum gain possible.
However, keep in mind that we do not need to hold the trade through expiration. If the position moves in our favor, we may consider an early exit within the next two weeks.
Position Sizing:
With a short call spread it is easier to calculate the maximum loss than an outright naked position. In this case you could consider the spread between the two strike prices ($1) minus the premium earned (68 cents) as the maximum loss (32 cents or $32 per contract) and amount “invested.” This should help you size your position so that if things don’t work out with the trade it won’t be too disruptive.
To learn more about executing this trade, watch the video here.
Note: It is important to understand the risks of trading options before you attempt a trade like this. This article is for educational purposes only.
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