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business newsBuy-Writes and FXI: An Options Strategy
How to collect the maximum profit.
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FTSE Xinhua China Index Fund (FXI) is an exchange-traded fund that holds 25 "H" and "Red Chip" stocks. Red-chip shares are Hong Kong-incorporated companies, while H shares are companies incorporated in the People's Republic of China.
One options strategist appears to like the idea. In morning trading Thursday, 20,000 July 38 calls traded for $1.29. These calls were sold against a position in FXI shares as part of a covered-call or "buy-write" strategy.
In most buy-writes, the strategist is selling one call for every 100 shares, and has a moderately bullish view on the stock or ETF. In this example, calls were sold for $1.29 against shares for $37.25.
Since the multiplier of an options contract is 100, the sale of the calls reduces the cost of owning FXI to $35.96 per share excluding commissions. $35.96 is now the downside break-even through the July expiration and if the ETF falls below that level, the covered call will show a loss. On the other hand, if FXI moves higher, the trade becomes profitable.
The maximum profit happens if the ETF closes at $38 or higher at July expiration (29 days from now). At that point, the shares will be “called away” for $38 and a 5.7% profit. If it fails to reach that level, the strategist can close the position or sell calls in a later expiration month, such as August.
Steve Smith has shown us Four Ways Buy-Writes Can Go Wrong. For real-time examples of buy-writes and other more advanced strategies, please click here.
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