This Could Be a Safe Haven in a Trade War
Trade wars are unusual in modern history. When they have unfolded, they have generally been limited to small skirmishes involving just one or two items. For example, during the Obama years, tire imports were the subject of tariffs for a time.
This time appears to be different. Countries around the world appear to be taking actions to escalate tensions which have been building in recent months. The U. S. has been out in front of other countries imposing a variety of tariffs, including a proposed 10% tariff on $200 billion worth of goods from China.
Now, other countries are responding.
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The WTO May Not Restore Calm Quickly
China said it filed a complaint to the World Trade Organization challenging President Donald Trump’s plan for tariffs on $200 billion worth of Chinese goods.
USA Today noted, “The announcement, from the Ministry of Commerce, came less than a week after the U.S. Trade Representative proposed a second possible tariff hike following a measure targeting $34 billion of goods.
The Chinese ministry said last week that China would immediately complain to the WTO over American unilateralism. Earlier this month, the Chinese government said tit-for-tat duties on U.S. goods took effect straight away after Washington’s 25 percent tariff on $34 billion worth of Chinese goods kicked in on July 6.
Washington imposed the tariff hikes in response to complaints that Beijing steals or pressures companies to hand over technology.
The $200 billion in goods sold to Americans every year represents about 40 percent of total U.S. imports from China.
Trump accuses China of unfair trade practices, such as subsidizing certain industries and ripping off American intellectual property. China says Trump is flouting established world trade rules and that it must protect its own economy.”
But, China is not the only country turning to the WTO for relief. ZeroHedge reports,
“The United States has launched five separate complaints at the World Trade Organization against Canada, China, the European Union, Mexico and Turkey, in response to retaliatory tariffs those countries and groups have launched against American products.
As CBC reports, the United States Trade Representative Robert Lighthizer said in a statement Monday that recent tariffs implemented by the U.S. on foreign steel and aluminum are “justified under international agreements,” but retaliatory measures from other countries in response are not.
“Instead of working with us to address a common problem, some of our trading partners have elected to respond with retaliatory tariffs designed to punish American workers, farmers and companies,” Lighthizer said.”
Finding Safety in a Trade War
For traders, the question is not about the politics of the trade war or which side has the better argument. The question is which assets could benefit from a trade war. Gold is one asset that traders should consider.
The weekly chart of SPDR Gold Trust (NYSE: GLD) is shown below. The price appears to be near support.
However, there is significant downside risk in the trade. The longer term chart using monthly data indicates significant support could be more than 10% below the current price.
An options strategy could provide a useful tool for investors who want to limit risk.
A Trade for Short Term Bulls
As with the ownership of any stock, buying GLD could require a significant amount of capital and exposes the investor to standard risks of owning a stock.
To reduce the risks of a trade, an investor could purchase a call option. This allows them to benefit from upside moves in the stock while limiting risk to the amount paid for the options. However, buying a call option can also require a significant amount of capital and includes the risk of a 100% loss.
Whenever an option is bought, the maximum risk is always equal to 100% of the amount of spent to purchase the option. Since options cost significantly less than a stock, the risk in dollar terms will usually be relatively small to own an option.
To further limit the risks of the trade, an investor could use a bull call spread. This strategy consists of buying one call option and selling another at a higher strike price to help pay for the cost of buying the first call. The spread strategy always reduces the risk of an options trade.
This strategy is designed to profit from a gain in the underlying stock’s price but has the benefit of avoiding the large up-front capital outlay and downside risk of outright stock ownership. The potential risks and rewards of this strategy are summarized in the chart below.
Source: The Options Industry Council
Both the potential profit and loss for the bull call spread are limited. The maximum loss is equal to the net premium paid when the trade is opened. The maximum profit is limited to the difference between the strike prices, less the debit paid to put on the position.
This strategy could be especially appealing with high priced stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.
A Specific Trade for GLD
For GLD, the August 17 options allow a trader to gain exposure to the stock.
An August 17 $118 call option can be bought for about $1.20 and the August 17 $119 call could be sold for about $0.40. This trade would cost $0.80 to open, or $80 since each contract covers 100 shares of stock.
The amount paid to enter the trade is the largest possible loss on the trade. This is generally true whenever a trader is creating a debit to enter an options trade. “Creating a debit” means there is a cost to enter the trade. You could create a debit by simply buying puts or calls to open a directional trade.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $80.
The maximum gain on the trade in GLD is equal to the difference in exercise prices less the amount of the premium paid to open the trade.
For this trade in GLD the maximum gain is $0.20 ($119 – $118 = $1.00; $1.00 – $0.80 = $0.20). This represents $20 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $80 to open this trade.
That is a potential gain of about 25% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.
In this trade, options provide income and defined risk. These are the type of strategies that are explained and used in TradingTips.com’s Extreme Profits Calendar service. This service uses seasonals as one indicator in its trade selection process. To learn more about how options can be used to meet your goals, click here for details on Extreme Profits Calendar.