China Bear Opts for a Long Put Spread on FXI

By opening this put spread, the trader is anticipating that FXI will drop below $38 by the time November-dated options expire. However, the speculator isn't looking for the exchange-traded fund (ETF) to fall too far -- the sale of the 33-strike put lowers the cost of entry and break-even point on the spread, but it also inherently limits his profit potential on a downside move.

The risk and reward breaks down like this: The spread was initiated for a net debit of $1.04, which is the maximum potential loss on the play. Break-even is $36.96, or the purchased put strike minus the net debit. Meanwhile, the maximum possible gain is $3.96, or the difference between the two put strikes, less the initial net debit.

Essentially, the ultimate goal is for FXI to settle squarely at $33 upon November expiration. This will reap the biggest possible profit on the long 38-strike puts, while the short 33-strike puts can be left to expire worthless.

On the charts, FXI has gapped drastically lower this week. The ETF has tumbled south of support at its 10-day, 20-day, 50-day and 200-day moving averages, so it's no surprise that FXI has garnered bearish attention from options traders.

However, rising support from FXI's 80-week moving average could wreak havoc with this long put spread -- this trendline acted as a key technical floor throughout the month of May, and it's currently rising toward the $39 level.

Elizabeth Harrow is a senior equities analyst and financial writer in the research department at Schaeffer's Investment Research. She is featured in the video series Schaeffer's Daily Q&A on SchaeffersResearch.com.