The long-awaited (and much needed) pullback has finally arrived. And it brings opportunity in its wake, particularly for emerging market stocks which have been on a tear. The iShares MSCI Emerging Markets Indx (ETF) (NYSEARCA:EEM) is forming its first significant two-day retreat since November. And dip buyers are already starting to swarm EEM.
Thus far, the selling pressure has been modest. Despite the 3% slide, EEM remains well above its 20-day moving average, which is rising like a rockstar. The magnitude of January’s breakout and subsequent follow-through suggests this uptrend is worth betting on. Skeptics viewing this week’s downturn as the beginning of a trend reversal will find their pessimism premature.
While profit-taking may take emerging market stocks down a few more days, deploying bullish trades into the weakness is a must. In sizing up potential options trades, we can use implied volatility to determine just how expensive premiums have become.
The implied volatility rank for EEM recently pole-vaulted to 89% (not shown). Remember, a rank of 100% means premiums are the most expensive they’ve been all year long. So, at 89%, prices are pumped. And the high volatility isn’t isolated to EEM. Just about every broad market ETF has seen a notable jump over the past week. And that means option selling strategies like covered calls and naked puts are finally offering handsome payouts.
On a side note, this volatility pop has been a long time coming. Low volatility has been plaguing option sellers, robbing them of decent payouts, for months. Rather than being shunned, this volatility uptick should be embraced and exploited with short premium strategies.
An EEM Buy-the-Dip Trade
Despite its meteoric rise, the price tag of EEM is still low enough to support naked put trades. Sell the March $48 put for around 50 cents. If the fund sits atop $48 at expiration, you will capture the initial premium. By selling the put, you are obligated to buy 100 shares at an effective purchase price of $47.50, which is an attractive entry point for future upside in the fund.
As of this writing, Tyler Craig held bullish positions in EEM. Want more education on how to trade? Check out his trading blog, Tales of a Technician.