Buy ETF Options to Profit From Latin Fever

While the U.S. market has been struggling, the signs of global recovery are out there. Just look at the current 52-week highs in the iShares MSCI Singapore Index Fund (NYSE: EWS), iShares MSCI Chile Investable Market Index Fund (NYSE: ECH) and Brazil Financials ETF (NYSE: BRAF). Or how about countries like India and Malaysia making bold moves? The WisdomTree India Earnings Fund (NYSE: EPI) is hitting two-plus-year highs, and the iShares MSCI Malaysia Index Fund (NYSE: EWM) is testing all-time highs.

In short, there are equity markets that are raging with bullish strength. And much of the global market strength is emerging from Latin American economies like Brazil, Chile, Mexico and Columbia, and I believe this will continue, so let�s look at how you can play this now.

I suggest one of my favorite global plays, and that’s an ETF that tracks a bright spot in the already strong Brazil economy. I like the Market Vectors Brazil Small-Cap ETF (NYSE: BRF), and specifically the BRF Jan 50 Calls, which last traded at $7.10 while BRF closed at $55. I prefer these in-the-money ETF options because they give you more breathing room to wait if needed as the move develops, without worrying that you’re getting stung much by time decay.

I mentioned BRF as one of two ETFs two buy in the BigTrends 2010 Market Outlook Report. So far it’s up 12% for the year, but I expect this outperformance to continue. You can join my Freemium club to gain access to this report as well as my The Next Generation ETF Portfolio report.

Let’s get back to why I chose the January $50 strike and the benefits of choosing this ETF option. For example, this option behaves more like an ETF substitute, because right away we have 5 points of intrinsic value and only 2 points of time value. This means that if the ETF stays stuck at $55 at the mid-January expiration date, we’d only lose the time portion of 2, which is just 28% of the total option’s value.

If BRF rallies to my target of $60.50 before the third Friday in January, the 50 strike call will be intrinsically worth $10.50, meaning more than a 50% gainer on a 5.5-point move up in the stock. The value here is that BRF has significant support at $50 and our target is conservative, so the reward-to-risk profile is strong. While this is not tremendous leverage, that’s only part of the reason to buy the option instead of the ETF. The other benefit is you’re only risking $710 (plus commissions, of course), rather than nearly eight times as much capital at risk if you bought 100 shares of the ETF at $5,500.

The Brazil economy has been among the most volatile due to changing global prospects, as this ETF traded around $25 in late summer 2009, and now trades more than 100% above that today. Of course, that doesn’t reflect the 27% drawdown earlier this year.

So why not just buy a diversified Latin American ETF like the iShares S&P Latin America 40 Index (NYSE: ILF)? Well, I’m thinking that leaders will continue to lead, while laggards continue to lag as the typically do. Don’t misunderstand my message, if BRF continues to surge, so will ILF, just not as much due to its broader diversity. BRF is also a great ETF based on the inner workings and holdings. Note that its top 10 holdings are well distributed and that no single company has more than 10% share of the total ETF holdings.

For the chartists watching the BRF’s price action, I love several things about this recent uptrend. The breakout over the past resistance at the $50 mark has now held successfully above that prior ceiling, making the old resistance a new support area on any pullbacks (hence the 50 strike selection). Clearly we’d like to see any pullbacks contained around the $50 area, and two closes under $50 would be enough to make me move to the sidelines and wait for another pickup in the future. (Remember, you can have all the big picture story right, but if the market does not support your view, you’re better off to keep any potential losses small and come back to play another day when all systems are go again.)

Note that I also follow the Williams Percent R indicator closely, and I’ve found that the strongest trends will actually STAY overbought much longer than anyone would expect. BRF fits the profile of an ETF that epitomizes a direct play on the global emerging market theme. Those getting on board this play will likely enjoy a profitable trade, and even if we do see it close below $50, our loss is acceptable given the reward potential.

If you are interested in learning more about my specific ETF strategies and would like access to Freemium TRADR subscription, sign up here. You will instantly receive my Top ETF Portfolio for the Next Generation free.

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