Investor Alert

New York Markets Close in:

Andrew Giovinazzi

Dec. 5, 2012, 11:44 a.m. EST

Cheap volatility, but big potential in China

By Andrew Giovinazzi

The market is setting into a pattern this month of news snippets and quiet selloffs. There has been no real momentum higher since our politicians can't come to a reasonable compromise. Besides the zealots on both sides, most people will pay a few more bucks for structural stability. The economy will grow and business will take risk if there is some reasonable conclusion that the government won't blow us out. That is really the issue now. If decision makers in companies big and small are holding back, what does that mean for new dollars coming into the market? The answer is no money is flowing in here. The market is illiquid and trading on noise.

Look at the VIX inch up in the face of very slow market activity . After trading the S&P 500 on the CBOE when I was younger, I can tell you what that feeling is. The paper is very thin, and it is buying options out of fear. Liquidity providers keep raising the prices since they don't want a large position right now waiting for some answer out of Washington. As I stated in my previous posts, any trade or initial investment has to look past this current malaise. I have been looking outside the U.S. to Asia to add a position.

The iShares FTSE/Xinhua China 25 Index (PSE:FXI)  has been on my list for a while. One of the biggest reasons is the implied volatility is trading at year lows making the relative prices of the options very cheap. Option prices just bounced off of the two-year low Tuesday. The timing was pretty good as the FXI is making a huge move up .90 today as the Asian market rips.

My thinking is that asian stocks will attract capital is short term and through the new year. Credit, debt and growth are not really a big issue there. The FXI is still under highs for the year and still far below the bubble years of 2007, but the momentum now is there. The cheap volatility makes entry here very attractive.

I do not like buying to hard into rallies, so here is the plan. Take your normal allocation and separate it into three parts and look to fill by the end of the year or on any significant back up. The dire news here might adversely affect the FXI, but only temporarily. Calls spreads will make the most sense since the premium is so cheap.

One example is for an investor to buy the FXI Mar 38/41 call spread in one-third of their normal allocation, building to the end of the year and holding until March expiration. If FXI trades much lower, the investor could close the short call and leave the long call for the ride back up.

Link to MarketWatch's Slice.