Use Options to Buy Brazil on the Cheap

12/30/2011 9:00 am EST

Focus: OPTIONS

Stutland Volatility Group cites fundamental growth drivers in Brazil and recommends selling puts on a primary Brazilian ETF in part because of the significant premium that can be collected.

Economic growth in 2012 will be minimal in the United States, non-existent in Europe, and slowing in China from the looks of current data. However, one place we see a big potential for growth is Brazil, whose underlying fundamentals are among the world’s strongest.

Brazil’s rapidly emerging middle class is the engine driving growth in the country. The labor market has been exceptionally strong in Brazil, with the unemployment rate at 5.8% and falling.

Another catalyst for growth is the rapidly approaching 2014 World Cup and 2016 Olympics. These events have prompted major government investments in infrastructure. Increased investment in airports, the power grid, railways, roads, hotels, and telecommunications will all have a long-term impact on Brazilian growth—all of which should transcend their current direct impact.

See related: 7 Attractive Brazilian Buys

Besides investment in infrastructure, the Brazilian government is spurring growth by creating a stable, increasingly transparent political climate. Recently, the government relaxed antitrust regulations in order to make Brazilian companies more competitive in global markets. The government has also shown a dedication to controlling the nation’s inflation, which has been decreasing for the past several months.

Additionally, the government has been slowly reducing interest rates in order to increase local companies’ access to capital. Further interest rate reductions should be bullish for the nation’s Bovespa stock index.

To capitalize on this growth, we recommend selling the March 50 put on the iShares MSCI Brazil Index Fund (EWZ). This ETF provides exposure to Brazilian equities without any exchange rate risk.

The March 50 put is trading with a 41% implied volatility, meaning there is a significant premium to be collected by selling the option. By being short the put, we are collecting cash upfront and waiting for this ETF to dip before buying.

If EWZ closes below $50, which is near the 52-week low of $49.25, we get to buy the ETF at an exceptional value. If EWZ is not trading below $50 at March expiration, the premium collected is yours to keep and is a way to get paid to wait for the perfect entry into this fund.

chart
Click to Enlarge

Here’s a quick summary of this trade. Be sure to check current pricing of the options. The prices below were valid at the time this article was written.

Stock/Index: iShares MSCI Brazil Index Fund (EWZ)
Option play: Short put
Sell: March 50 put @ $1.50
Net cost: $1.50 credit
Breakeven: $48.50 = 50 – 1.50 (Short strike – Net credit)
Max profit: $1.50 (Net credit)
Max loss: $48.50 = 50 – 1.50 (Short strike – Net credit)

By the Staff at Stutland Volatility Group

Stutland Volatility Group offers clients investment vehicles through a few different areas: SVG can enhance returns and mitigate risk by using volatility as an asset class to protect portfolios, utilize overlay strategies to add income to stock, ETF, and index positions using options, and aid in creating a sound financial plan and investment strategy to help execute long stock and bond portfolios to grow wealth.

Related Articles on OPTIONS