Tariffs Could Lead to Trade Wars and Trading Opportunities
For many, tariffs are simply the subject of a monotonic quote delivered by Ben Stein in the 1986 movie, Ferris Bueller’s Day Off. Stein’s comments have been memorized and repeated by economics students for more than thirty years now.
“In 1930, the Republican-controlled House of Representatives, in an effort to alleviate the effects of the… Anyone? Anyone?… the Great Depression, passed the… Anyone? Anyone? The tariff bill? The Hawley-Smoot Tariff Act? Which, anyone? Raised or lowered?… raised tariffs, in an effort to collect more revenue for the federal government.”
Stein explained, “It did not work, and the United States sank deeper into the Great Depression. Today we have a similar debate over this.”
Tariffs have actually been debated in the United States since the country’s founding and that debate continues today. Recently, tariffs were back in the news.
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Solar Panels Lead to a Tariff Case
Last month, the U.S. International Trade Commission recommended tariffs on imported solar panels of as much as 35%. The independent agency will send its proposals to President Donald Trump, who faces a January deadline to make the final decision.
The agency had voted unanimously in September that U.S. solar manufacturers were being harmed by cheap imports. But, the commissioners were split on what action to take.
One commissioner proposed tariffs of 3% on solar panels and as much as 30% on solar cells, beyond an initial quota that would face lower duties. Two other commissioners jointly proposed a 30% duty on cells beyond 1 gigawatt of imports.
Those recommendations would all be temporary. In both cases the duties would last for four years and decrease in regular intervals.
There is also another proposal for the President to consider. The fourth commissioner recommended import quotas of 8.9 gigawatts for the first year, increasing by 1.4 gigawatts annually over the same period. The President has a great deal of discretion in deciding what to do next.
A Calendar Based Trading Strategy for the News
Below is a chart of First Solar Corporation (Nasdaq: FSLR). It covers the last year. Earnings reports are highlighted by blue arrows.
First Solar provides solar energy solutions in the United States and internationally. The company designs, manufactures, and sells cadmium telluride solar modules that convert sunlight into electricity.
First Solar is the biggest U.S. solar manufacturer. But, the company uses a different technology than most other manufacturers and that means its products are exempt from the trade dispute. Analysts have said the company stands to gain the most from tariffs, if they are implemented.
First Solar also provides turn-key photovoltaic solar power systems or solar solutions, such as project development; engineering, procurement, and construction; and operating and maintenance services to utilities, independent power producers, commercial and industrial companies, and other system owners
From this chart, we can see a general trend. The stock seems to make a big move on the earnings announcement and then settle into a trading range. This is a pattern that is seen in many large cap stocks.
Large cap stocks tend to be followed by a number of Wall Street analysts. This means news from the company is quickly transmitted to all traders and the implications of the news are almost immediately priced into the stock. That explains the large moves and then the subsequent trading range while we await the next bit of news from the company.
Since earnings are only announced once every three months, we can assume that First Solar is likely to remain in a relatively narrow trading range for at least several weeks.
This tendency is especially likely to hold in the coming weeks as the industry waits for the decision from the White House on what form tariffs will take. It is possible there will not be any tariffs although that outcome seems unlikely. The White House has expressed a desire for tariffs in a number of industries in the past.
The earnings pattern combines with the news in this case to make a strong argument for a trading range in shares of First Solar.
One options strategy that benefits from a stock in a trading range is an iron condor. This strategy has the added benefit of carrying limited risk.
To open an iron condor trade, the investor sells one call while buying another call with a higher exercise price and sells one put while buying another put with a lower exercise price. Typically, the exercise prices of the calls are above the market price of the stock and the exercise prices of the put options are below the current price of the underlying stock.
In an iron condor, the difference between the exercise prices of the two call options will be equal to the difference between the exercise prices of the two put options. The final requirement for this strategy is that all of the options must have the same expiration date.
The risks and potential rewards of the strategy are shown in the following diagram.
Source: The Options Industry Council
The maximum gain on this trade is equal to the premiums received when the position is open. The maximum risk is equal to the difference in the two exercise prices less the amount of the premium received when the trade was opened.
Trading Opportunity: Opening an Iron Condor in First Solar
For First Solar, the trade can be opened using the following four options contracts:
As you see, all of the options expire on the same day, Friday, December 15.
The difference in the exercise prices of the calls or puts is equal to $3.50. Since each contract covers 100 shares of stock, this means the maximum risk on the trade is equal to $350 less the premium received when the trade was opened.
Selling the options will generate $2.45 in income ($1.55 from the call and $0.90 from the put). Buying the options will cost $1.15 ($0.65 for the call and $0.50 for the put). This means opening the trade will result in a credit of $1.30, or $130 for each contract since each contract covers 100 shares.
The maximum risk on the trade is equal to the difference in strike prices ($3.50) minus the premium received ($1.30). This is equal to $2.20, or $220 since each contract covers 100 shares. Many brokers will require a margin deposit equal to the amount of risk. That means this trade may require just $220 in capital.
The maximum gain on the trade is the amount of premium received when the trade is opened. In this case, that is $1.30 or $130 per contract.
The potential reward on the trade ($130) is about 58% of the amount risked, a high potential return on investment for a trade that will be open for less than one month. If a trade like this is entered every month, a small trader could quickly increase the amount of capital in their trading account.
The iron condor is an example of how options are a versatile tool and could meet many of your trading objectives. In this trade, options provide income and defined risk that should be lower than owning the stock.
These are the type of strategies that are explained and used in TradingTips.com’s Options Insider service. To learn more about how options can be used to meet your goals, click here for details on Options Insider.