One trade for uncertain markets

  My favorite ETF is EWZ which tracks Brazilian Index. It is trading 8 times earnings and yielding 6.17% in dividends. Just for comparison, IWM, Russell 2000 index trades at 15 PE and yields 1.39%. INP, tracking Indian Index trades at 21 PE.

    I am bullish on EWZ, don’t mind outright buying the shares today at market price of $56.92 but would be a greater buy, if the shares drop lower. In this article I will discuss about a trade called Put Ratio Spread and how I can place that trade on EWZ, to suit my situation.

   In a put ratio spread, we buy puts at higher strike price and selling more puts at lower strike price to offset our cost. In case of EWZ, I can buy one Feb,2012 57.00 put for $2.80 which will cost me $280 and sell three Feb,2012 51.00 puts, for $0.96 which will give me credit of $288.  Placing this trade will cost me nothing or almost nothing and I will be buying the stock for $48.00, if it craters below $51.00

   On the options expiration date, for every dollar the stock drops below $57.00, this trade will gain $100 up to $51.00. For every dollar the stock drops below $51.00, this trade will loose $200. Maximum possible profit is $600. Break even price is $48.00. Maximum loss will be $9600, if stock goes to $0.00.

  If the stock is higher than $57.00 on options expiration date, we neither gain nor loose anything. Even if the stock is higher this trade could be closed for gain, few days before options expiration because lower strike puts decay faster than higher strike puts.

Disclaimer: This article does not constitute individual investment advice. It is only for entertainment.

Source: Yahoo Finance.

Disclosure: I own put ratio spread on EWZ.