Options For Both Sides Of China Fund FXI

August 13, 2015

This is a weekly column focusing on ETF options by Scott Nations, a proprietary trader and financial engineer with about 20 years of experience in options.

Exchange-traded funds make it easy to get instantaneous exposure to asset classes that might otherwise be difficult to participate in. Options on ETFs make it possible to get that instantaneous participation in payoff profiles that would otherwise be impossible.

On Wednesday, one institutional trader did both, using options to generate a unique payoff profile in the iShares China Large-Cap ETF (FXI | B-40) just after news broke that China was devaluing its currency in a surprise move.

FXI had a difficult second quarter, as you can see below, but the damage was manageable until the beginning of July, when the entire Chinese equity market swooned. FXI traded below $40 before recovering slightly. Now one institutional option trader is taking advantage of the turmoil to collect a premium by selling options at elevated levels, while speculating that FXI won’t fall below $39.

FXI traded as low as $38.88 on July 8, as the selling of Chinese equities reached its peak, so it’s easy to see why our option trader believes the $39 level will be the low for any future move.

How This Trade Works
To collect some premium and take advantage of his belief that $39 would be a floor, this trader sold 15,118 shares of the FXI $39 strike puts expiring in August for $0.54. The expiration date for August options is Friday, Aug. 21, so our option trader won’t be at risk for very long.

By selling these puts, our trader agrees to purchase 1,511,800 shares of FXI at $39.00 per share (each contract represents 100 shares), if the owner of the options decides to exercise them prior to expiration. The owner of the options will choose to exercise them if FXI is below $39.00 at expiration. In exchange for agreeing to buy FXI options if they’re below $39.00, our option seller collected $0.54 per share, or a total of $816,372.

Selling a put on FXI allows the put-seller to collect and keep the option premium. As long as FXI is above $39.00 when the options expire, that will be the put-seller’s profit. After expiration, he would be free to take his money and sell new put options or look for a new strategy.

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