Follow the Bears Down Under for Profits

by Tyler Craig | September 24, 2012 12:45 pm

Although U.S. equities have posted stellar returns in 2012, the bullish festivities have thus far been largely a domestic affair. China, Europe and most emerging markets have watched from afar as the U.S. markets have climbed to new bull market heights.

While emerging markets received a much-needed boost in response to the recent announcement of QE3[1], it remains to be seen whether the Fed-induced euphoria will lead to lasting change. With ongoing signs of a global economic slowdown, the possibility remains that emerging markets will continue to underperform.

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The accompanying chart includes a comparative relative strength study (green line) showing the iShares MSCI Emerging Markets Index (NYSE:EEM[2]) has exhibited relative weakness versus the S&P 500 Index for much of the year.

With its rich natural resources and export-based economy, Australia is one potential victim of poor global growth[3]. Traders looking for bearish exposure to the country down under might consider structuring positions on the CurrencyShares Australian Dollar Trust (NYSE:FXA[4]).

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One play worth consideration is entering the November 105-101 bear put spread. To initiate the position, traders would buy to open the Nov 105 put while selling to open the 101 put for a net debit of $1.60 or better.

The max risk is limited to the initial $1.60 paid at trade inception, and will be incurred if FXA sits above $105 at November expiration. The max reward is limited to the distance between strikes minus the net debit ($4 – $1.60 = $2.40) and will be captured if FXA resides beneath $101 at November expiration.

Note: Liquidity is a bit lacking in FXA options, so traders should use limit orders to ensure the best fill possible on their orders.

In the event the pace of global growth worsens and/or risk aversion seizes investors heading into year’s end, the Australian dollar should be one victim on the casualty list.

As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.

  1. to the recent announcement of QE3:
  2. EEM:
  3. Australia is one potential victim of poor global growth:
  4. FXA:

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