September 14, 2015
Under $300 Bet on China Could
Make Traders 45% Profits
By Joseph Hogue
For five years, investors wondered if China's growth story was dead and its market would ever rise again. Then late last year, investors began rushing back in, sending the Shanghai Composite zooming higher.
The index surged nearly non-stop until June of this year, when it looked like the government might not make its 7% growth target for 2015.
The drop that followed was just as spectacular as the meteoric rise, with the Shanghai Composite falling roughly 40% from its June high.
The Chinese government has allowed these stock market losses on the grounds of free market reforms. But there's little doubt that it has the means to pull its market out of the tailspin -- and there are several signals the government may take action very soon.
Even after spending a record $100 billion to prop up its currency last month, China still has $3.56 trillion in foreign reserves -- more than any other country. With the base interest rate at 4.6%, the central bank has room to cut rates and enact other policy measures. And as a command economy, the government has the mandate to directly control economic growth.
The question looming over the market has been at what point the government finally says, "Enough is enough."
China About to Give the Green Light
As I mentioned, there are several signs we are approaching such a point. For starters, Zhou Xiaochuan, governor of the People's Bank of China (PBOC), recently told finance ministers of the G20, "The correction in the stock market is already mostly over."
For any other country, such a statement might sound like an official trying to support the market with optimistic sentiment. But for a government that so directly controls its economy and financial markets, it's more than just verbal support.
Second, the government consulted with BlackRock (NYSE: BLK) CEO Larry Fink on the market situation and potential solutions in August -- a sign China may be contemplating novel ways to support the markets in addition to its usual arsenal of banking stimulus and infrastructure spending.
In the meantime, more traditional stimulus could be coming soon. Any policy measure could take months to work through to the economy. As a result, the government typically prefers to make changes toward the end of the year, as it gives measures enough time to boost the economy before New Year's celebrations around the beginning of February.
This was evident in 2011 when policymakers followed a November banking reserve cut with a December confirmation that they would support easing measures to stimulate growth. The government also approved 60 infrastructure projects totaling more than $157 billion in September 2012. And in September of last year, the PBOC injected $81 billion into the nation's five largest banks.
Add it all up, and China's government could be on the verge of long-awaited action.
Turn a 10% Move Into a 45% Profit
The most liquid way to play China is with the iShares China Large-Cap ETF (NYSE: FXI), which holds shares of the 50 largest Chinese companies on the Hong Kong Exchange.
I particularly like FXI as a play on stimulus because nearly half of the fund is weighted to financials. Interest rate cuts, liquidity injections and loan approvals have been China's preferred method of stimulus to date and would directly benefit this sector.
FXI traded around $40 before the yuan devaluation in mid-August. Any stimulus measures could easily drive shares back up to that point, which is 10% above recent prices.
But I don't plan to buy shares.
Back in May, I was bearish on China's market, so I used a simple put option strategy to turn an 8% move in FXI into a 54% profit in less than two months.
Now, I want to use a bullish call option strategy to turn the potential 10% upside move in FXI into a 45% profit.
If you're not familiar with options, or even if you are, there is one name in the business you should know. This trading prodigy actually made a 39% profit with an FXI option in just seven days. That's an amazing 2,036% annualized return.
His strategy consistently delivers outsized returns, with average annualized gains of 123% per trade. To learn more about it or get his latest recommendation sent directly to you, follow this link.
With FXI trading at $36.34 at the time of this writing, I can buy the FXI Dec 36 Calls for around $2.75 a share ($275 per contract, which controls 100 shares). My breakeven price of $38.75 ($36 strike price plus $2.75 option premium) is 7% higher than the market price, but my upfront investment is a fraction of what it would cost to buy the shares directly.
If my $40 target for FXI is hit before the option expires on Dec. 18, the option would be worth at least $4 ($40 ETF price minus $36 strike price) for a 45% return in just over three months. I will set a good 'til cancelled order at $4 for the options after opening the position.
The December options expire the week of the Federal Reserve meeting when the U.S. central bank is widely expected to raise rates. I expect China to have enacted policy measures before this as a way to preempt any weakness from a stronger U.S. dollar and rate-related market fear.
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