With All Eyes on Asia, Many Traders Missed This Story
There are plenty of reasons to pay attention to events in Asia. There is the possibility of a trade war with China and the possibility of peace talks with north Korea, at some point in time. The recent decision to cancel talks set for June is possibly a prudent decision to give both sides more time to prepare.
These stories are important and should hold the attention of traders. But, some traders have been watching events in Brazil where problems are mounting.
Truckers Strike at the Oil Company
Earlier this week, more than 200,000 of the country`s 1 million truck drivers began striking, threatening food and fuel shortages in Rio de Janeiro. The strike also threatens industries ranging from meatpacking to automobiles and soybeans.
A depreciation in Brazil’s currency, the real, to a two-year low against the dollar, together with surging oil prices, is driving up fuel costs. This is combining with political uncertainty over elections in October, and investor doubts over Brazil’s troubled fiscal situation.
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“If this strike grows and it spreads and you can’t control it, you can have a supply meltdown,” according to Tony Volpon, economist at UBS. “We are totally dependent on road transport so when truckers start striking, the government does tend to get really concerned.”
Brazil’s diesel prices before taxes and distributor markups increased almost 30% since March 1 while petrol prices are up about 27.5%, according to state-owned oil company Petrobras.
The Brazilian real, the country’s currency, fell by about 15% against the dollar last week before recovering slightly after central bank intervention.
Brazil’s state-led oil company Petrobras responded by temporarily cutting diesel prices by 10% to help the government and truck drivers resolve the crisis.
Petrobras Chief Executive Officer Pedro Parente said the price cut, which will only remain in place for 15 days and cost the company about 350 million reais ($96 million), was not in response to any government demands.
“The independence of Petrobras has not been damaged,” Parente said at a news conference explaining the decision. “It was an exceptional measure and does not represent a change to our pricing policy.”
Near-daily price adjustments at Petrobras have let the company track global prices and turn a profit on fuel sales after losing money for years at the government’s insistence, part of a turnaround that lifted shares nearly 90% since the pricing policy started last July, as the long term chart shows.
Traders, however, do appear to be concerned in the short term and responded to news of the temporary price cut by selling shares of PBR. The sell off undercut an important support level.
It seems unlikely that PBR will make a strong recovery from the recent sell off.
A Trading Strategy While Awaiting Better News
To benefit from the expected weakness in the stock, an investor could buy put options. But, high prices on put options suggests an alternative trading strategy. The option premium is high because the expected volatility of the stock is high. Options that are based on selling an option can benefit from high volatility.
In this case, with a bearish outlook, a call option should be sold.
Selling options can involve a great deal of risk. A spread options strategy can be used to limit the potential risk of the trade.
One strategy that is important to consider is the bear call spread. This trade uses two calls with the same expiration date but different exercise prices. Traders buy one call and sell another call. The exercise price of the call you sell will be below the exercise price of the long call, so this strategy will always generate a credit when it is opened.
The risk profile of this trading strategy is summarized in the diagram below.
Source: The Options Industry Council
The trade has limited up side potential and limited risk. But, this strategy will allow traders to generate potential gains in a stock they might otherwise find too risky to trade.
The maximum potential gain with this strategy is equal to the amount of premium received when the trade is opened. The maximum loss is equal to the difference between the exercise price of the options contracts less the premium received.
A Bear Call Spread in PBR
For PBR, we have a number of options available. Short term options allow us to trade frequently and potentially expand our account size quickly. Short term trades also reduce risk to some degree since there is less time for a news event to surprise traders.
In this case, we could sell a June 15 $14 call for about $0.40 and buy a June 15 $15 call for about $0.20. This trade generates a credit of $0.20, which is the difference in the amount of premium for the call that is sold and the call.
Since each contract covers 100 shares, opening this position results in immediate income of $20. The credit received when the trade is opened, $0.20 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $80. The risk is found by subtracting the difference in the strike prices ($100 or $1.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($20).
This trade offers a potential return of about 25% of the amount risked for a holding period that is about three weeks. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if PBR is below $14 when the options expire, a likely event given the stock’s trend.
Call spreads can be used to generate high returns on small amounts of capital several times a year, offering larger%age gains for small investors willing to accept the risks of this strategy. Those risks, in dollar terms, are relatively small, about $80 for this trade in PBR.
These are the type of strategies that are explained and used in our TradingTips.com’s Options Insider service. To learn more about how options can be used to meet your income and wealth building goals, click here for details on Options Insider.