Bullish EEM Trade from Monday

As CBOE expands the number of markets available for trading to include foreign indexes we are going to do the same in this space every Tuesday through taking a look at derivatives based on the MSCI family of indexes.  With the weakness in global markets on Monday I decided to search around for a trade in EEM ETF options that may be trying to take the other side of low equity prices.

The daily chart below shows that EEM was down about 2.4% which was a bit more than the drop in the S&P 500 (2.09%) on Monday.  This is typical when there is weakness across the board in global equity markets as emerging market stocks are in considered risker investments when compared to developed markets.

EEM Chart

At least one trader seems to think the drop in EEM is going to be short lived and that emerging market stocks will rebound.  With about an hour left in the trading day on Monday someone sold the EEM Jul 17th 40.00 Puts at 0.92 and purchased EEM Jul 17th 38.50 Puts at 0.12 for a net credit of 0.80.  The payoff diagram below shows the profit and loss profile for this trade at expiration along with the closing price for EEM from Monday.

EEM PO

EEM over 40.00 at expiration would result in a profit equal to the 0.80 credit received.  On the other end of the spectrum, if EEM is below 38.50 at expiration the loss will be 0.70 as the short put will be worth 1.50 more than the long put.

Buying on dips is sometimes referred to as “catching a falling knife”.  This phrase implies that when a trader tries to catch a falling knife they may lose a finger.   Yesterday afternoon, with the S&P 500 and Dow Jones Industrial Averages closing near the lows of the day, buying the dip can be profitable, but also a fairly difficult trade when you are going against a trend.  This bull put spread is a good example of how options may be used to buy a dip, but keep all your digits if the trade does not go your way.