The markets continue to be edgy with the news of additional 10 percent tariffs on $200 billion of Chinese products which will then be raised to 25 percent by the end of the year. President Donald Trump is playing the tariffs card in an effort to convince China to agree to our proposed trade deal terms.
When I say edgy, I mean that the S&P 500 after the first nine months of the year is still within 1 percent of its February high while the Shanghai Stock Exchange is down more than 24 percent. In fact, several of the global financial markets are entering correction territory while the U.S. stock exchanges continue to show resiliency during the trade war.
Could now be the time that China is ready to make a deal? If so, its stock market could be set to skyrocket, or at least go back to flat on the year — remember, it’s down more than 24 percent.
Let’s take a look at what I like to call “The Better Call.”
This is a three-legged setup. The trade has limited losses yet unlimited profits while still maintaining a high probability of profit. By buying the 40 Call, selling the 41 Call and buying the 44 Call in FXI (Ishares Trust China Large-Cap ETF) in the October cycle, we are able to set up a trade that has a 60 percent probability of profit with a kicker.
The total risk in the trade is the debit paid of $85. The current price of FXI is $41.08. While this is a bullish trade, it can go down to the breakeven of $40.85 and still be profitable. But most importantly, any point over $40.85 is profitable. So FXI can sit as long as it wants at the current price of $41.08 and this trade would still profit.
As long as the trade stays above $40.85 at expiration, there is a minimum return on capital of 17 percent, which is the difference in the width of the 40-41 Call Strikes minus the debit paid. But the best part of this trade is that if FXI goes back to flat on the year, at roughly $48, then the return on this trade would grow significantly.
In fact for every $1 that FXI moves over the long call strike of $44 the return would be $100. So if FXI returned to $48 the profit on this trade would be $415 or nearly a 500 percent return on capital.
The probability of FXI reaching $48 by the October expiration is only 2 percent according to the Tastyworks platform. But there is a chance with the White House pushing so hard on China that a deal can be made and if so, that could propel FXI — and your brokerage account — to new highs on the year.
Trade Idea Recap
Expiration: October 19, 2018
Strikes: Buy 40 Call, Sell 41 Call, Buy 44 Call
Trade Price: $85 Debit
Total Risk: $85