Japanese stocks have dropped in recent days as a bout of profit-taking has cooled the white-hot market. But honestly the mild downturn couldn’t have come at a better time. Last week’s epic two-day 10% jump in Japan’s Nikkei 225 Index launched Japanese stocks into orbit and had would-be buyers just begging for some type of pullback for better entry.
As reported last week the bull run was driven by “the Bank of Japan’s surprise announcement of a stimulus plan.”
The recent hoopla in Japanese stocks is perhaps best viewed using the WisdomTree Japan Hedged Equity Fund (DXJ). DXJ provides a purer view of price action in Japanese equities by eliminating the affects of any fluctuations in the value between the Japanese Yen and the U.S. Dollar.
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The accompanying chart shows last week’s mega-gap along with the recent pullback. Despite some longer-term resistance levels looming overhead (not shown) the short- and intermediate-term technicals remain rosy for DXJ, placing the odds squarely in favor of the bulls.
How to Trade Japan
Traders wishing to board Japan’s bull market with a high probability play should sell bull put spreads on DXJ. The bull put spread offers a limited risk way of betting Japanese stocks don’t fall much further from their lofty perch.
The profits will come quicker, however, if Japan’s market can continue its upward thrust into year-end.
Consider entering the Dec $52/$48 bull put spread by selling the Dec $52 put and buying the Dec $48 put for a net credit of 65 cents. The max reward is limited to the initial 65 cents and will be captured provided DXJ sits atop $52 at Dec expiration. Since the delta of the Dec $52 put is around 30, the options market is pricing in about a 70% chance that you will capture the max reward at expiration.
The max risk is limited to the distance between strikes minus the net credit, or $3.35, and will be incurred if DXJ rests below $48 at Dec expiration. To limit the potential loss, you could exit if DXJ breaches the 50-day moving average around $51.
As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.
