Exchange-traded funds (ETFs) offer covered call writers and put-sellers the advantage of instant diversification and generally have a lower implied volatility associated with them compared to individual stocks. Whether we are dealing with stocks or ETFs each security must be evaluated on its own merit before using it as the underlying security. In this article, I am highlighting ASHR (DB X-trackers Harvest CSI 300 China A-Shares) which provides cap-weighted exposure to the Chinese equity market, where foreign investors have historically had very limited access. This is because China has a “mostly closed” capital account, whereby investors, as well as companies and banks, cannot move money in and out of the country except in accordance with strict rules. Capital account liberalization is part of China’s current reform efforts, and the fact that this exchange-traded fund exists is evidence that China is moving to open up its capital markets. The inception of this ETF was 11-6-13 and the security now holds net assets over $1.4 billion.
This security earned its way onto our Premium ETF Report in late July, 2014 and has remained there ever since. Let’s have a look at the technical chart over the past year:
ASHR became a staple of the Premium ETF Report in late July, 2014 after the 20-day exponential moving average (EMA) crossed above the 100-day EMA and the price bars continued to remain at or above the short-term EMA. The price in July was $24.00 and as of 6-12-15 it is above $55.00.
Implied volatility both an asset and a liability
Many Chinese securities that trade on US exchanges (American Depository Receipts or ADRs) are highly volatile due to the nature of the Chinese economy and the lack of transparency associated with these stocks or ETFs. This is a factor we must all consider before using ASHR as an underlying security. As of 6-9-15, ASHR’s implied volatility was three and a half times that of the S&P 500 (45.85 compared to 13.50). This means we are incurring more risk to the downside when utilizing this security. The good news is that this high level of volatility results in higher option premiums. On 6-9-15, with ASHR trading at $54.72 I checked the option chains for the July 17, 2015 $50.00, $55.00 and $60.00 strike prices. The results represent five-week returns. Here is the information as shown in the multiple tab of the Ellman Calculator (for a free copy click on the “Free resources” link on the top black bar of this page):
- $50.00: 2.2% or 22% annualized
- $55.00: 5.4% or 54% annualized
- $60.00: 2.6% or 26% annualized
Potential final one-month returns
- $50.00: 2.2% but comes with 8.6% downside protection of the 2.6% profit
- $55.00: 5.9%
- $60.00: 12.5%
It would make sense to favor the $50.00 strike price because we are generating a nice 2.6% five-week return which will realized as long as share value does not decline by more than 8.6% by expiration Friday.
Both the near-the-money $55.00 and the out-of-the-money $60.00 strikes make sense because both offer favorable initial five-week returns. The $60.00 strike is the most aggressive position to take because it offers the highest potential total returns although lower initial returns than the $55.00 strike.
The calculator also shows us that the higher the strike we select, the greater is our potential total return but also the more risk we are incurring as the breakeven also moves higher.
Our Premium ETF Reports will identify securities that are out-performing the S&P 500 and some, like ASHR, can out-perform over a significant time frame. When such an exchange-traded fund is identified, we still need to evaluate additional factors before including it in our option-selling portfolios. We must be certain that the premium returns meet our goals and the implied volatility matches up with our personal risk tolerance. Another decision that must be made regarding ASHR is whether we are comfortable with a Chinese security which is notoriously less transparent than a corresponding US security. If these criteria meet our trading requirements there can be enormous opportunities with an ETF like ASHR.
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Greece’s financial future continues to look uncertain after another week of debt negotiations yielded no significant results. This week’s economic reports:
- US retail sales rose 1.2% in May after a 0.2% increase in April, with gains in 11 of 13 major categories
- The University of Michigan’s preliminary index on consumer sentiment climbed more than expected to 94.6 in June from a final reading of 90.7 in May
- The National Federation of Independent Business’ Small Business Optimism Index climbed 1.4 points to 98.3 in May, the highest reading since December
- US producer prices increased 0.5% in May mainly due to a rise in fuel costs
- Wholesale prices fell 1.1% year-over-year
- An increase in fuel costs pushed US import prices 1.3% higher in May from a year earlier, the largest increase since March 2012 and coming after 10 straight months of declines
- Fuel costs rose 11.8%, the most since mid-2009
- Excluding fuel, import prices were unchanged in May
- The US Bureau of Labor Statistics reported 5.4 million job openings in April, up from 5.0 million in March and the highest monthly reading since data collection began in December 2000
- Initial jobless claims increased 2,000 to 279,000 for the week ended 6 June, the 14th straight week under 300,000
For the week, the S&P 500 rose by 0.1% for a year-to-date return of 1.7%.
IBD: Confirmed uptrend
GMI: 6/6- Buy signal since market close of May 11, 2015
BCI: Cautiously bullish favoring out-of-the money strikes 3-to-2
Wishing you the best in investing,
Alan ([email protected])