Wade Into a Choppier China With Options

Use low-cost options to dip your toe into the region’s rebound

By Jim Woods, Editor-in-Chief, Successful ETF Investing, Stock Investor's Blueprint


Investing in China used to be an easy proposition. You would just buy the big China names, then some of the major international stocks pegged to the fortunes of the world’s second-largest economy, and — voila! — the profits came pouring in.

Well, that was then, and this is now — and making money in China today is about as easy as finding a capitalist quoting Adam Smith at an Occupy Wall Street protest.

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As friend, colleague and Investorplace Editor Jeff Reeves recently pointed out, there are at least five key issues at play that make investing in China a risky bet. And while I agree with Reeves about the strong headwinds in China such as an ugly housing market and the lack of trustworthy economic data coming out of the country, I also think there are tailwinds that could send many beaten-up China-related stocks higher in the months ahead.

Perhaps the biggest tailwind comes from the Chinese government and the People’s Bank of China, or PBOC. In an attempt to juice up its slowing GDP growth, Chinese policymakers slashed interest rates not once, but twice, in June. They also trimmed banks’ required reserve ratios in three 50-basis-point increments since last November. That move has released an estimated 1.2 trillion yuan ($190 billion) for new lending, and that capital is sure to have a positive effect on the economy going forward.

Of course, this extra liquidity has just begun to work its way through the system, so it’s too early to tell just when this stimulus will kick in. What we do know is that so far, there hasn’t been any significant uptick in inflation due to cheaper cost of capital. In fact, the Chinese CPI print for August was up just slightly to 2% for the month, and that’s following July’s 30-month low of 1.8%.

Another strong driver for China and related stocks going forward is the recently announced news that the Chinese government will undertake a massive stimulus package estimated at $158 billion-plus. I detailed the implications of this in a recent article, but in short, the country has plans to build 1,254 miles of roads, nine new sewage-treatment plants, five port improvement projects, two waterway system enhancements and 25 new subway projects.

This large amount of capital from monetary easing, as well as the infrastructure spending bump, likely will find its way down to a few sectors and companies positioned to profit. Of course, that might take awhile, so instead of putting a large amount of capital to work buying stocks and waiting for China’s stimulus to bear fruit, why not get into a few China plays with low-cost call options?

One sector poised to profit from the China story is raw materials — specifically copper, iron ore, coal and aluminum. In other words, the building blocks essential to massive infrastructure projects. One of the biggest mining and materials companies out there, and the leader in the copper space, is Freeport-McMoran Copper & Gold (NYSE:FCX).

Shares recently have surged past both short- and long-term technical levels, thanks in large part to the China build-up news, and of course, to the news that the Federal Reserve will keep the money spigot open on “QE Infinity.” Here I like the slightly out-of-the-money FCX Nov 2012 42 call. At a price of $1.66, it will only cost you $166 to control the option to buy 100 FCX shares — far less than $4,093 it would cost you if you bought 100 shares of FCX at Sept. 20’s close (both transactions exclude commissions and transaction expenses).

Another low-cost options candidate for a China rebound is iconic construction equipment maker Caterpillar (NYSE:CAT). The world’s biggest supplier of earth-altering machines is likely to get a lot of business from those 1,200-plus miles of roads to build, and that boosted demand for Cat tractors will be felt across the next several quarters. Getting in front of that demand with the CAT Nov 2012 95 call at just $2.71 ($271 per contract) is a low-cost alternative to buying 100 shares of CAT at $92.54, or $9,254.

Finally, if you think there will be a boost in China, why not own the right to control 100 shares of the benchmark iShares FTSE China 25 Index (NYSE:FXI)? Here the FXI Nov 2012 36 call at $59 cents, or $59 per contract, is a lot easier than putting up $3,452 to buy 100 shares at Sept. 20’s closing price.

If you want to wade into China without risking a whole lot of capital, then do so using these low-cost options.

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

Article printed from InvestorPlace Media, https://investorplace.com/2012/09/wade-into-a-choppier-china-with-options-cat-fcx-fxi/.

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