My Trade in FXI

• stevenplace
• April 17th, 2009

While optimism and thoughts of a generational bottom are permeating market sentiment, I by nature remain skeptical of how far we’ve come and how quickly we got here. So while I’ve been surfing the trend in this raw sewage, I find it prudent to both take profits and look for potential short opportunities.

From a technical basis, when you have a rally this sharp, you need a really good rationale with getting in a trade. So what I personally like to do in trades like this is find price points in the past where supply exceeded demand. I’m also looking for a large grouping of these points to help me put on a low-risk trade. Because when it comes to countertrend trading, you should be focusing on the risks rather than the potential rewards.

Here’s the chart for FXI:

So we’re coming up to some pretty heavy levels of resistance where I think current holders in the name might start selling, and if we continue with that thesis we could see a pretty decent pullback.

So I looked around on the options chain to see if I could find any trades that some whales were picking up. Lo and behold:

So essentially someone was trading 1x the 32 puts and 3x the 30s. So they were getting into a backspread (either buying or selling). If you have the tick data you could see which side they were getting in, but I think they were selling the 32s and buying the 30s, due to the positive vega the position has.

Now I know there’s at least a few of you that are saying that I can’t view this trade in isolation and that there may have been a stock trade paired up with it… well, you’re right. My guess is that the position was initiated and that they *are* expecting a pullback, but they’re essentially going to use this as trading around the gamma.So as FXI pulls back, they will continue to purchase shares in FXI, the delta risk being offset by the option position.

They also make good money if volatility comes back anytime soon. The following day there were 20k/10k contracts traded around the May 32/33 calls and 29k/20k traded around the 32/30 puts; so someone out there is definetly getting long vol, and I have a feeling it’s the same group of people putting on these positions.

Anyways, I like the backspread by itself. Here’s the risk profile:

This is a delta negative play that is limited risk and unlimited reward. The major upside to this trade is that it has a ton of gamma in it as well as a ton of vega. So if we get both a pullback as well as a volatility uptick, the position will do quite well. Do notice that the most you can lose is at the 30 strike at expiration; however, I don’t plan on holding the position for quite that long.

Now since we’re really close to violating my technical thesis, I will exit out of the trade on any further strength. There is some risk of an overnight gap up (especially since this is a China etf) but this is basically being used as a hedge that hedges more the further the market falls.

I’d say worst case stop would be strength above 33.4, which would put your loss at about 60 bucks before commissions. So while I’m nervous that I’m so close to my stoploss, it also helps me increase my position size due to a fixed R.

The way I’ll be taking profits is that at the first sign of lower highs, I’ll move my stop just above that high. A 50% retrace of the current move in FXI would put the stock price around 28 bucks, which would be about 300 profit before commissions, and not including any vega movement. So we’re looking at a potential 5R trade, which I think is quite feasible.

Of course, now that I’ve gone through the trouble of explaining my trade, we’ll probably rally even further with an opex squeeze.

If you liked this post but are new to options, check out Options Bootcamp. It’s an hour long video on the behavior of options and how to trade basic strategies. I personally made it so my style is in the video, making it much easier to understand the nature of the options market. You can get it here.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

Tickers: fxi

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