Amid Market Volatility, This Spread In Options Trading Bets Against Emerging Markets

As stocks bounce up and down while the U.S.-Iran war persists, investors who expect continued tension in the Middle East might consider a bear call spread on the iShares MSCI Emerging Markets (EEM) exchange traded fund, or EEM stock.

President Donald Trump signaled Monday morning that the U.S. and Iran are holding productive talks and said he’s willing to hold off on strikes against Iranian power plants for five days.

This marks a quick reversal from earlier inflammatory rhetoric in which Trump threatened to strike the plants if that nation did not open the Strait of Hormuz within 48 hours.

Stocks opened significantly higher Monday on hopes of an easing conflict. However, the situation remains extremely volatile. Iranian media is currently denying that the “constructive talks” Trump described actually took place, and Israel continues to strike Iran.

Given the uncertainty, traders may want to focus on risk management via the bear call spread. There is no harm in sitting on the sidelines. That said, options spreads offer a compelling alternative in volatile conditions, providing a clearly defined risk-to-reward profile.

Placing A Bear Call Spread On EEM Stock

In a bear call spread, an investor sells a call option at one strike price while buying another call option at a higher strike price. With EEM stock trading around 57, investors could consider selling the 55 call and buying the 60 call, both expiring May 15.

This trade currently offers a credit of about 2.75, based on recent trades. That also represents the maximum profit of $275 per 100-share contract if shares trade below 55 at expiration.

The maximum loss amounts to the difference between the strike prices, or $5, minus the credit received, or $2.75. Take that $2.25 and multiply that by 100 to reach $225 for the 100-share contract.

As of Monday late-morning trading, the spread between the two calls widened to just under $2.95.

Also, investors would realize this maximum loss if shares trade above 60 at expiration.

Heavy Asian Holdings

While global stock markets have been broadly affected by Middle East tensions, Asian equities have been hit particularly hard due to the region’s heavy dependence on the Strait of Hormuz for oil supply.

Although EEM is a global ETF, it is heavily concentrated in Asia. China, Taiwan, and India alone account for over 60% of the fund’s holdings.

Further, EEM stock currently trades between its 50-day and 200-day moving averages. It also holds a Relative Strength Rating of 80, according to MarketSurge data.

Steven Bell is a writer and trader based out of Vancouver, British Columbia. He is the author of IBD’s Income Investor column, focused on shedding insight on low-risk, underfollowed stocks.

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