Sentiment Says This Options Trade Can Win Big By September

ETFs, Global Investing, Options

Following traders making huge bets on market moves is one great way to find a new trade to place. Jay Soloff, the options trading expert at Investors Alley, saw one trader placing a $350,000 bet the stock in this article is going to make a big move soon. Here’s how you can mimic this trade in your account. 

Most US-based investment analysts focus on the US markets for obvious reasons.  It doesn’t hurt that the United States, generally speaking, has the biggest most active financial markets in the world.  However, savvy investors shouldn’t ignore opportunities in other countries’ stock markets as well.

Of course, it’s easy these days to invest in stocks all around the world using ETFs.  You can invest by region, country, emerging, developed, frontier, small, large, government-run, and everything in between.  Just 10 to 15 years ago, many of these investments would have been impossible for the average investor to make.

One of the most common non-US investments is in stocks from other major developed nations.  Those countries typically include Japan, UK, France, Germany, Australia, Switzerland, Hong Kong, and a few others.  Notice that China is not considered a developed country yet (due mostly to the regulatory environment) but Hong Kong is.  If you look at a major developed country index like EAFE (Europe, Australasia, and the Far East), the largest holdings are usually from Japan, followed by UK, and then the rest of Europe.

So what should we expect from EAFE in the second half of 2017?  Well, one thing we can do is see what the options market is saying.  Keep in mind, you have a lot of “smart” money using the options market for major investments and trades.  It can be a very good way to get an idea of sentiment on stocks and ETFs.

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For instance, this past week in iShares MSCI EAFE Index ETF (NYSE: EFA), someone purchased the August 18th 66 straddle 2,500 times.  That means the person purchased both the call and put at the 66 strike, and they’re hoping for movement in either direction before August expiration.  More specifically, the buyer paid $1.38 for the straddle, so break even points would be at roughly $64.60 and $67.40.

As you can see from the chart, EFA has been range bound since about May.  So why would someone suddenly expect the ETF to jump to new 52-week highs or drop below the current range by mid-August?  It’s not like the straddle is particularly expensive, but why buy it near the top of what has been an obvious range?

One reason for the trade could be related to the political situation in the US.  If the current presidential impeachment talk continues to gain steam, investors could flee US stocks and move into other developed country stocks.  Or perhaps volatility in the US due to the political drama will cause a dip in global stocks as investors move to bonds.  There are any number of scenarios which could play out, and they all involve potential movement in EFA.

While EAFE stocks and US stocks often move in unison, it’s not always the case – especially when country specific news can change the fundamental picture.  What’s more, options in EFA are relatively cheap, making it a more attractive target for straddle buyers.

So what can you do if you believe global stocks are about to get more volatile?

I like the idea of using EFA because the options are cheaper than other major stock indexes.  But, I’d personally buy more time for the situation to play out.  August can be slow some years with investors waiting to make big decisions until September.

As such, you could buy September 15th options in EFA and gain an extra month.  Moreover, I’d consider using a strangle instead of a straddle to keep the cost low.  For example, the 65-67 strangle in September only costs about $1.25 (buying the 65 put and the 67 call).  That puts your break even points at $63.75 and $68.25.  It’s a bit wider than the straddle trade we looked at, but it costs less and gives us an extra month of control.  More importantly, if EAFE stocks do make a big move, this trade could generate big returns.