A new year is upon us and the market is closing in on January expiration. Time to update the strategies we covered back in October.
Back in October, Stutland Volatility Group released a few options-oriented trades on broad emerging markets — as embodied by iShares MSCI Emerging Markets ETF (NYSE:EEM) — and Brazil in particular iShares MSCI Brazil Index ETF (NYSE:EWZ).
These strategies used January covered call options, so it is time to examine how they performed and update them:
iShares MSCI Emerging Markets Index ETF (NYSE:EEM)
The goal of this strategy was to capture the upside of the attractive growth that emerging markets offer. At the time, EEM was trading at $45.50 and the January $48 call option was valued at $1.38. As of last night, EEM had climbed to $46.91 and the January call was worth $0.38. As a result, the initial investment returned a total of $336 ($236 for the underlying ETF appreciation and $100 for the call write) per 100 shares of EEM. This is a total return to date of 7.4%, which is a lot better than the 3.0% that traders would have gotten from simply buying EEM and holding — and the downside was protected as a bonus. Stutland believes maintaining this position until expiration is the right play. If the EEM finishes over $48 at January expiration tomorrow, the position will have returned a total 8.5% over the four-month period. At this point, the call is assigned (“called away”) and the trader is taken out of the position with a very nice return.
iShares MSCI Brazil Index ETF (NYSE:EWZ)
In October, many of the big banks expected Brazil to benefit from a weaker dollar, strong domestic economic growth and rising commodity prices.
However, the broad Brazil ETF EWZ has failed to appreciate and is currently trading at $76.07, well below the $77.12 where it was in October. This demonstrates the risk management component of the covered call strategy — traders who took Stutland’s suggestion would still be in the money while more traditional buy-and-hold investors have printed a loss.
The original trade was to buy 100 EWZ shares at $77.12 and sell an $81 January call option for $2.48 a share. This dropped the effected break-even point on the position down to $74.64.
As a result, covered call traders are up 2% on Brazil whereas simply holding the ETF would have delivered a 1.3% loss.
With the market closing in on January expiration, the sale of the January $81 call is no longer providing much protection due to the call’s lack of value.
Stutland is recommending the investor “roll the position.” This means covering (buying in) the January call write and writing (selling) another call further out on the time horizon.
For example, someone could buy in the January $81 call for $.03 and write (sell) the March $80 call for $2.20. The trade generates 2.8% for the two-month expiration cycle and again, lowers the break-even on the EWZ purchase while generating the opportunity for further upside gains on the investment.
In a covered call options strategy, a trader buys shares of a stock or ETF and also sells an option to buy the stock or ETF at a higher price in the future. This generates immediate income in the form of the market price of the option the trader sells — and that income may enhance the overall trade’s risk-adjusted performance.
Emerging Money provides insightful and timely information about the increasingly important world of Emerging Market investments. CNBC Emerging Markets Contributor Tim Seymour leads the team of Emerging Money to bring you cutting edge global news and analysis.
About Tim Seymour: Tim is a founder of Emerging Money. He is a founder and Managing Partner at Seygem Asset Management, and The Emerging Markets Contributor to CNBC. Seygem Asset Management focuses on investing throughout the global emerging markets asset class. With a view that emerging and developing economies will continue to outpace the economic growth and advancement of developed economies, Seymour has devoted a career to investing in the dominant markets of tomorrow, today. Seymour’s career has included significant experience in both alternative asset management (hedge funds) and capital markets, having launched two hedge funds, and built the largest Russian broker dealer in the USA. Seymour started his career at UBS, focusing on international credit (cash, swaps, forex) in a specialized hedge fund group (New York). Seymour completed the firm’s training program after graduating with an MBA in international finance from Fordham University. Seymour received his undergraduate degree at Georgetown University.