Trade war fears and a strong U.S. dollar continued to weigh on China and emerging markets stocks this week. But prices have fallen to such low levels that contrarians are starting to take note. I share their interest and think the time is ripe for a bullish play on the Emerging Markets ETF (NYSEARCA:EEM). EEM offers a broad-based way to bank on a rebound in this beaten-down area.
Thus far this year’s performance in EEM has been the polar opposite of 2017. Whereas last year, the fund did nothing but rise, this year it’s done nothing but plumb the depths. Since peaking at $52.08 in late-January, EEM has fallen 21% to its current perch of $41. We’ve now retraced just shy of 50% of the bull run that began in 2016.
What makes this “official” bear market even worse is that it’s transpired while U.S. stocks have been flying high. If emerging market stocks were biting the dust alongside American equities, it would lessen the blow or at least make the weakness easier to swallow.
Moving to the daily chart reveals greater clarity on the descending channel that EEM has been stuck in this year. The series of lower highs and lows have been consistent and confirmed by the falling moving averages.
But here’s where my optimism comes in. We’ve seen a handful of vicious rebounds when emerging markets became oversold this year.
We can use the Stochastics indicator to illustrate these prior episodes. I’ve highlighted all four in the accompanying chart. Since peaking slightly above $44, EEM has fallen 8% over the past two weeks. And with that, the Stochastics has returned once again to oversold territory. Tack on Tuesday’s beautiful bullish reversal candle and strong close and I think the time is ripe for a snap-back.
Sell Naked Puts
At 45%, the implied volatility rank for EEM options is high enough to make short puts attractive. Selling the Oct $40 puts provides a solid return with a high probability of profit. You can enter the trade for a 60 cent credit. The initial margin requirement is around $700, which translates into a return on investment just shy of 10%.
As of this writing, Tyler Craig held bullish EEM options positions. Want more education on how to trade? Check out his trading blog, Tales of a Technician.