One way to participate in the resurgence of the Chinabull trend
is through the
iShares FTSE China 25Index Fund (
FXI
)
. Thisexchange-traded fund (
ETF
) is made up of 25 of China's corporate leaders, and can
potentially smooth out the volatility associated with the
individual companies.
The China story has gone quiet during the past few years, with
FXI trading in a range from $48 to $32 since 2009. Since the
September 2012 low of $32, FXI has recovered with a nearly 25%
bounce, placingshares just above the $40 midpoint of the trading
range.
A rally to the upper end of the sideways channel gives a
conservative target of $48. Longer term, a breakout targets $56 a
share, which is still significantly below the 2007 highs above $70.
Only a close below the $32support level on a weeklybasis would
negate thebullish trend.
The $48 target is about 20% higher than current prices, but
traders who use a capital preserving,stock substitution strategy
could make triple-digit profits on a move to that level.
One major advantage of using longcall options rather than buying
the stock outright is putting up much less to control 100 shares --
that's the power ofleverage . But with all of the potential strike
andexpiration combinations, choosing anoption can be a daunting
task.
Simplyput , you want to buy a high-probability option that has
enough time to be right, so there are two rules traders should
follow:
Rule One: Choose an option with 70%-plus
probability.
Delta is a measurement of how well an option follows the
movement in the underlying security. It is important to buy options
that pay off from a modest price move in the stock orETF rather
than those that only makemoney on the infrequent price
explosion.
Any trade has a 50/50 chance of success. Buyingin-the-money
options increases that probability. Delta also approximates the
odds that the optionwill bein the money at expiration. In-the-money
options are more expensive, but they're worth it, as your chances
of success are mathematically superior to buying cheap,
out-of-the-money options that rarely pay off.
For example, with FXI trading at about $40 at the time of this
writing, an in-the-money $35 strike call currently has $5 in real
orintrinsic value . The remainder of any premium is thetime value
of the option.
Rule Two: Buy more time until expiration than you may
need -- at least three to six months -- for the trade to
develop.
Time is an investor's greatestasset when you have completely
limited the exposure risks. Traders often do not buy enough time
for the trade to achieve profitable results. Nothing is more
frustrating than being right about a move only after the option has
expired.
With these rules in mind, I would recommend the FXI Jan 2014 35
Calls at $6 or less.
A close below $32 in the stock on a weekly basis or the loss of
half of the option premium would trigger an exit. If you do not use
a stop, the maximum loss is still limited to the $600 or less paid
per option contract. Theupside , on the other hand, is unlimited.
And the January 2014 options give the bull trend almost a year to
develop.
This trade breaks even at $41 ($35 strike plus $6 option
premium). That is about $1 above FXI's current price. If shares hit
the upside breakout target of $48, then the call options would have
$13 of intrinsic value and deliver a gain of more than 100%.
Action to Take -->
Buy FXI Jan 2014 35 Calls at $6 or less. Set stop-loss at $3. Set
initialprice target at $13 for a potential 117% gain in one
year.
This article originally appeared on ProfitableTrading.com:
A Resurgence in This Bull Trend Could Deliver
Triple-Digit Profits