A Global ETF Option to Buy Now

09/20/2010 10:57 am EST

Focus: OPTIONS

The signs of global recovery are still out there, despite the lack of US market strength since May. Whether you look at the current 52-week highs in Singapore (EWS), Chile (ECH), Brazilian financials (BRAF), or at countries making bolder moves like India (EPI) hitting two-year highs or Malaysia (EWM) testing all-time highs, there are equity markets that are raging with bullish strength. Much of the global market strength is emerging from Latin American economies like Brazil, Chile, Mexico, and Columbia, and I believe this will continue.

So how do you play this now?

I suggest one of my favorite global plays, and that's an exchange traded fund (ETF) that tracks a bright spot in the already strong Brazilian economy. Specifically, I like the Market Vectors Small-Cap Brazil ETF (BRF) January 2011 $50 calls (BRF 012211C50), which last traded at $7.10 while BRF closed at $55.00. I prefer these "in-the-money" ETF options because they give you more breathing room to wait if needed as the move develops, without worrying that you're getting stung much by time decay.

I mentioned BRF as one of two ETFs two buy in the BigTrends 2010 Market Outlook Report. So far, it’s up 12% for the year, but I expect this outperformance to continue.

Let’s get back to why I chose the January $50 strike and the benefits of choosing this ETF option. For example, this option behaves more like an ETF substitute, because right away, we have 5.00 points of intrinsic value and only 2.00 points of time value. This means that if the ETF stays stuck at 55 at the mid-January expiration date, we'd only lose the time portion of 2.00, which is just 28% of the total option's value.

If BRF rallies up to my target of 60.50 before the third Friday in January, the 50-strike call will be intrinsically worth 10.50, meaning more than a 50% gainer on a 5.50-point move up in the stock. The value here is that BRF has significant support at 50 and our target is conservative, so the reward-to-risk profile is strong. While this is not tremendous leverage, that's only part of the reason to buy the option instead of the ETF. The other benefit is you're only risking $710 (plus commissions, of course), rather than nearly eight times as much capital at risk if you bought 100 shares of the ETF at $5,500.

The Brazilian economy has been among the most volatile due to changing global prospects as this ETF traded around 25 in late summer 2009, and now trades more than 100% above that today. Of course, that doesn’t reflect the 27% drawdown earlier this year.

Why not just buy a diversified Latin American ETF like ILF? Well, I'm thinking that leaders will continue to lead, while laggards continue to lag, as they typically do. Don’t misunderstand my message, if BRF continues to surge, so will ILF, just not as much due to its more broad diversity. BRF is also a great ETF based on the inner workings and holdings. Note that its top ten holdings are well distributed and that no single company has more than 10% share of the total ETF holdings.


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For the chartists watching the BRF ETF price action, I love several things about this recent uptrend. The breakout over the past resistance at the 50.00 mark has now held successfully above that prior ceiling, making the old resistance a new support area on any pullbacks (hence the 50 strike selection). Clearly, we'd like to see any pullbacks contained around the 50 area, and two closes under 50 would be enough to make me move to the sidelines and wait for another pickup in the future (remember, you can have all the big picture story right, but if the market does not support your view, you're better off to keep any potential losses small and come back to play another day when all systems are go again).

Note that I also follow the Williams percent R indicator closely, and I've found that the strongest trends will actually stay overbought much longer than anyone would expect. BRF fits the profile of an ETF that epitomizes a direct play on the global emerging market theme. Those getting on board this play will likely enjoy a profitable trade, and even if we do see it close below 50, our loss is acceptable given the reward potential.


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By Andrew Hart of ETFTradr.com

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