Yesterday, we looked at a Daily Price Chart of Republic Services, Inc. noting that the stock’s OBV line is sloping up, validating the recent bullish trend.
For today’s Trade of the Day e-letter we will be looking at a daily price chart for the iShares MSCI Emerging Markets ETF, symbol: EEM.
Before breaking down EEM’s daily chart let’s first review the investment objective of the ETF.
The EEM ETF generally will invest at least 80% of its assets in the component securities of its underlying index and in investments that have economic characteristics that are substantially identical to the component securities of its underlying index. The index is designed to measure equity market performance in the global emerging markets. The underlying index includes large- and mid-capitalization companies and may change over time.
Now, let’s begin to break down the Daily Price chart for the EEM ETF.
Below is a Daily Price chart with the 50-Day EMA and 100-Day EMA for EEM.
50-Day EMA and 100-Day EMA ‘Sell’ Signal
The 50-Day Exponential Moving Average (EMA) and 100-Day EMA are moving average indicator lines that can provide buy and sell signals when used together. When the shorter-term 50-Day EMA crosses above or below the longer-term 100-Day EMA, this provides either a buy or sell signal depending on which direction the stock price is moving.
- 50-Day EMA line Above 100-Day EMA = Price Uptrend = Buy signal
- 50 Day EMA line Below 100-Day EMA = Price Downtrend = Sell signal
When the 50-Day EMA (blue line) crosses above the 100-Day EMA (red line) this indicates that the ETF’s buying pressure has begun to outweigh the selling pressure signaling a ‘buy’ signal. When the 50-Day EMA crosses below the 100-Day EMA this indicates that the selling pressure has begun to outweigh the buying pressure signaling a ‘sell’ signal.
As the chart shows, on August 5th, 2021, the EEM 50-Day EMA, crossed below the 100-Day EMA.
This crossover indicated the selling pressure for the EEM ETF exceeded the buying pressure. For this kind of crossover to occur, an ETF has to be in a strong bearish trend.
Now, as you can see, the 50-Day EMA is still below the 100-Day EMA meaning the ‘sell’ signal is still in play.
As long as the 50-Day EMA remains below the 100-Day EMA, the ETF is more likely to keep trading at new lows and bearish positions should be initiated.
Our initial price target for EEM is 35.65 per share.
80.3% Profit Potential for EEM Option
Now, since EEM’s 50-Day EMA is trading below the 100-Day EMA this means the ETF’s bearish decline will likely continue. Let’s use the Hughes Optioneering calculator to look at the potential returns for an EEM put option purchase.
The Put Option Calculator will calculate the profit/loss potential for a put option trade based on the price change of the underlying stock/ETF at option expiration in this example from a flat EEM price to a 12.5% decrease.
The Optioneering Team uses the 1% Rule to select an option strike price with a higher percentage of winning trades. In the following EEM option example, we used the 1% Rule to select the EEM option strike price but out of fairness to our paid option service subscribers we don’t list the strike price used in the profit/loss calculation.
Trade with Higher Accuracy
When you use the 1% Rule to select an EEM in-the-money option strike price, EEM only has to decrease 1% for the option to breakeven and start profiting! Remember, if you purchase an at-the-money or out-of-the-money put option and the underlying ETF closes flat at option expiration it will result in a 100% loss for your option trade! In this example, if EEM shares are flat at 38.36 at option expiration, it will only result in a 1.3% loss for the EEM option compared to a 100% loss for an at-the-money or out-of-the-money put option.
Using the 1% Rule to select an option strike price can result in a higher percentage of winning trades compared to at-the-money or out-of-the-money put options. This higher accuracy can give you the discipline needed to become a successful option trader and can help avoid 100% losses when trading options.
The goal of this example is to demonstrate the powerful profit potential available from trading options compared to ETFs.
The prices and returns represented below were calculated based on the current ETF and option pricing for EEM on 9/13/2022 before commissions.
When you purchase a put option, there is virtually no limit on the profit potential of the put if the underlying ETF continues to decline in price.
For this specific put option, the calculator analysis below reveals if the EEM ETF decreases 5.0% at option expiration to 36.44 (circled), the put option would make 39.5% before commission.
If the EEM ETF decreases 10.0% at option expiration to 34.52 (circled), the put option would make 80.3% before commission and outperform the stock return more than 8 to 1*.
The leverage provided by put options allows you to maximize potential returns on bearish ETFs.
The Hughes Optioneering Team is here to help you identify profit opportunities just like this one.
Interested in accessing the Optioneering Calculators? Join one of Chuck‘s Trading Services for unlimited access! The Optioneering Team has option calculators for six different option strategies that allow you to calculate the profit potential for an option trade before you take the trade.
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Wishing You the Best in Investing Success,
Editor, Trade of the Day
Have any questions? Email us at email@example.com
*Trading incurs risk and some people lose money trading.