Friday, November 27, 2009

Establish iShares MSCI China ETF Covered Calls

An additional covered calls position was established today in iShares MSCI China ETF (FXI) as follows:

Established iShares MSCI China ETF (FXI) Covered Calls for Dec09:
11/27/09 Bought 400 FXI @ $42.54
11/27/09 Sold 4 FXI Dec09 $44.00 Calls @ $1.13

China continues to rank #1 in this advisor's '2009 Country Value Rankings'.
Some of the key value-oriented metrics for China are as follows:
- Real GDP growth of approximately 8.5% in 2009 and 9.0%+ in 2010. This compares with a projection of slightly negative growth this year in most of the world's major developed countries and perhaps 2.0% to 4.0% in 2010.
- Estimated current-year inflation of 0% to 1% in China.
- Price/Book ratio of 3.03 is a below-average valuation relative to many other countries (for example, the U.S. S&P 500 is currently at 3.37).

The FXI ETF was selected as the primary investment vehicle for achieving wide exposure to China's stock market performance. It consists of market-cap-weighted positions in the 25 largest companies in China, and although it is most heavily weighted in the financial, energy, and telecommunications sectors, it still provides a relatively good way to diversify across the Chinese economy. Since China remains as the Covered Calls Advisor's top investment idea, a major commitment of 17% of the total CCAP is now allocated to FXI covered calls. Moreover, as a direct reflection of this Advisor's current bullishness regarding China, a bullish covered calls position(3.4% out-of-the-money) was established. Normally, the Covered Calls Advisor establishes buy/write positions by buying the underlying equity and simultaneously selling the call options. However, because of the news regarding the possible delay in Dubai's debt payments and the associated substantial sell-off at the market's open today, it was decided to leg-in to this covered calls position by buying the 400 shares of FXI at $42.54 soon after the market opened. Ninety minutes later, when FXI had risen to $43.41 the Dec09 $44.00 options were sold at $1.13.

Some possible overall performance results(including commissions) for this FXI investment would be as follows:
Stock Purchase Cost: $17,024.95
= ($42.54*400+$8.95 commission)

Net Profit:
(a) Options Income: +$440.05
= (400*$1.13 - $11.95 commissions)
(b) Dividend Income: +$0.00
(c) Capital Appreciation(If stock price unchanged at $42.54): -$8.95
= ($42.54-$42.54)*400 - $8.95 commissions
(c) Capital Appreciation (If stock exercised at $44.00): +$575.05
= ($44.00-$42.54)*400 - $8.95 commissions

Total Net Profit(If stock price unchanged at $42.54): +$431.10
= (+$440.05 +$0.00 -$8.95)
Total Net Profit(If stock exercised at $44.00): +$1,015.10
= (+$440.05 +$0.00 +$575.05)

Absolute Return if Stock Price Unchanged at $42.54: +2.5%
= +$431.10/$17,024.95
Annualized Return If Unchanged (ARIU): +42.0%
= (+$431.10/$17,024.95)*(365/22 days)

Absolute Return if Stock Exercised at $44.00: +6.0%
= +$1,015.10/$17,024.95
Annualized Return If Exercised (ARIE): +98.9%
= (+$1,015.10/$17,024.95)*(365/22 days)

The downside breakeven price for this out-of-the-money position is $41.41 ($42.54-$1.13), and as such provides a downside profit protection of up to 2.5% below the purchase price.

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