The ongoing commodities crash has not been kind to emerging markets. In fact, it seems that no other region has been hit harder.
Let’s not mince words. The price action in the iShares MSCI Emerging Markets ETF (EEM) has been all sorts of ugly. Shares have tumbled 20% since late April, breaking support levels aplenty in the process. EEM sits below all major moving averages, and recently reached a new 3.5-year low. The last time prices visited this region was during the sovereign debt crisis-fueled plunge of 2011.
But while prices could continue plumbing the depths here, we’re overstretched enough for contrarian (that is, bullish) plays to start looking interesting.
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The stochastic indicator included in the accompanying chart certainly supports such an idea. Prior forays of the indicator to these lowly levels usually precipitated some type of rebound in the price of the EEM ETF.
On the volatility front, option premiums have inflated notably over the past month. And why shouldn’t they? EEM has been bucking and weaving, leading to higher realized volatility.
And elevated fears of continued destruction in the emerging markets space are leading investors to happily pay up for protection in EEM options. The pumped-up option prices are a good thing for premium sellers. It generates more income, providing a greater buffer should things turn sour.
The IV rank in EEM options has risen to 62%, its highest level in a month.
Generate Income With Naked Puts on EEM
The oversold conditions coupled with expensive options creates an attractive opportunity to sell naked puts. If you’re willing to bet EEM doesn’t fall much further from current levels, or if you’re looking to begin buying shares of EEM at these low prices, you could sell the Sep $34 put for 56 cents or better.
Your potential profit is limited to the initial 56-cent premium and will be pocketed if EEM sits above $34 at expiration.
If your broker holds aside 15% of the price of EEM in margin requirement (roughly $550), then your potential return on investment is 10%. Not bad for a month’s worth of work.
By selling the put, you obligate yourself to buy 100 shares of stock at the $34 strike. Since you received 56 cents up front, your true cost basis should you be assigned would technically be $33.44.
As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.
