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ETFs: Smooth Sailing Gives Way to Choppy Waters


Options traders anticipate volatility in exchange-traded funds.

Editor's Note: This post is by David Russell, of OptionMONSTER.

After 6 weeks of smooth sailing, options traders are anticipating volatility in emerging-market exchange-traded funds.

Activity spiked yesterday in the MSCI Brazil Index (EWZ) and MSCI Emerging Markets Index (EEM), which both witnessed above-average volume. In 1 of the session's largest trades, an investor purchased 33,000 contracts of EEM May 28 puts for $1.69 and an equal number of May 28 calls for $1.49.

This so-called straddle trade will be profitable if EEM falls below $24.82, or rises above $31.18. EEM rose 1.45% yesterday to close at $28.07. (See optionMONSTER's Education section.)

Another large transaction showed how 1 trader bet on a limited decline at very low cost. This strategy bought 5,000 May 26 puts in EEM for $0.96 and sold 10,000 May 24 puts at an average price of $0.465. By selling more puts at the lower strike, the cost was reduced to just $15,000 before commissions.

The maximum return would be $1 million if EEM closes at $24 on expiration. If it drops below $22, however, the trade would become unprofitable because of the greater short exposure at the lower strike.

The trade differs from a traditional spread, which is perfectly hedged because it includes an equal number of short and long positions. The transaction was similar to a large bearish position taken yesterday against the MSCI International ETF (EFA) - which focuses on developed countries like the United Kingdom and Japan.

Yesterday's activity could reflect concern about a pullback in stocks. If the market were to retreat, international and emerging-market equities would likely post larger losses because they tend to make more dramatic moves than US shares. Since the market's low last month, EEM has rallied 35%, compared with 25% for both the EFA and the S&P 500.

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No positions in stocks mentioned.

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