Viruses Can Spark Sell-Offs — Here’s Proof

Timor Invest
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Investor Insights:

• The coronavirus has already caused dozens of fatalities in China.
• A similar scare in 2003 pushed Chinese stocks 15% lower in six months.
• Today, China is the source of a profitable trading opportunity.

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“Don’t worry about the coronavirus outbreak.”

That’s what many analysts are telling investors right now, citing history. But they aren’t looking at all the facts.

And it’s giving investors a false sense of security.

It’s true that previous virus scares had little impact on U.S. stocks. But increasing globalization makes it likely a virus will affect the United States one day.

And local markets do, in fact, react to outbreaks.

Let’s look at how a local market reacted in a prior panic, what that means for the markets today — and how you can take advantage of panic selling.

In one example, the SARS scare in 2003 didn’t really affect U.S. stocks. But that scare pushed Chinese stocks 15% lower in six months. So anyone with exposure to this market was hit.

The 2003 SARS Scare Rocked Chinese Stocks

SARS was first reported in Asia in February 2003. Within months, the virus spread to more than two dozen countries in North America, South America, Europe and Asia before it was contained.

According to the World Health Organization, the virus sickened more than 8,000 people, and almost 10% of them died.

There were just eight confirmed cases in the U.S. Given the small number of infections here, it’s not surprising U.S. stocks weren’t affected.

But as the chart above shows, the Chinese stock market took a big hit.

That’s true today as well.

If the coronavirus breaks out in the United States, it would be bad news for U.S. stocks. But for now, the greatest risks are in China.

And that makes China the source of a profitable trading opportunity.

Bad News for the Chinese Stock Market

The coronavirus has already revealed something important about Chinese stocks: Many investors are ready to sell.

This can be seen in the chart of the iShares China Large-Cap ETF (NYSE: FXI) below.

Investors Couldn’t Wait to Sell FXI

FXI is an exchange-traded fund (ETF) that tracks an index of Chinese stocks. The ETF fell sharply at the open when news of the virus broke.

A large decline at the open, 4.3% in this case, shows sellers were lined up waiting for trading to start. They couldn’t wait to sell, and there are more investors who will sell if prices keep falling.

In addition to the price chart, momentum indicators confirm the sell signal. These include a stochastic divergence on the weekly chart.

1 Trade to Benefit From Weakness

To trade this sell signal, buy put options on FXI.

A put option gives the buyer the right, but not the obligation, to sell the ETF at a specified price any time before the option expires. It increases in value when prices fall.

To collect a gain, you simply close the option with a sell order, just like you do with stocks.

Options offer defined risks. You can never lose more than you paid for the option. Risks are generally small in dollar terms since options often trade for just a few hundred dollars.

Specifically, for this signal, the June 19 $40 put on FXI trades at about $2. If the index drops by 10% or more, the option will deliver a gain of more than 70%.

Now, there’s no guarantee this signal will work. But history says there’s a high probability of a decline in FXI right now.

That would deliver a short-term gain for traders owning put options.

Regards,

Michael Carr, CMT, CFTe

Editor, Peak Velocity Trader

P.S. All of the trades in my Peak Velocity Trader service are mathematically engineered and coded with three levels of safety checks to give you the opportunity to turn every $10,000 invested into $77,300 over the course of just one year. To find out more, click here.