A Cheaper and Lower-risk Way to Bet on Emerging Markets' Second-quarter ETF Rebound

As the second quarter begins, a new opportunity in the global market is emerging, and the options prices associated with it have never been more affordable. Here's the breakdown.

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The MSCI All Country World Index ETF (ACWI) recently achieved an all-time high. This index offers investors a diversified exposure to global stock markets, including developing countries, unlike the MSCI World Index tracked by the ETF 'URTH.'

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At first glance, one might assume that including developing countries in ACWI versus URTH doesn't make a meaningful difference. Both charts closely resemble the chart for the S&P 500 Trust (SPY).

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The reason behind this remarkable similarity lies in the dominance of the U.S. stock market in publicly traded equities. The U.S. market constitutes nearly 71% of the URTH ETF and almost 64% of the ACWI ETF.

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However, examining the actual returns of these ETFs since April 1st, 2020, through Good Friday reveals some performance distinctions. ACWI has generated a total return of 98%, URTH 108%, and SPY 126% by the end of last week. The variance in performance is largely due to the significant underperformance of emerging market equities.

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This underperformance is evident in the MSCI Emerging Markets Index, which is represented by the iShares ETF, 'EEM.' Over the past decade, the total return of SPY is approximately 233%, significantly higher than the 23% total return of EEM.

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Now, let's delve into the trade opportunity. Just as the character Miracle Max in "The Princess Bride" explained the difference between mostly dead and all dead, EEM has shown signs of life since its mid-January lows below $38. However, chasing equities in the midst of a recent rally can be unsettling.

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Fortunately, despite the overall market surge, some options premiums have remained low. EEM's three-month at-the-money "implied volatility," which indicates options traders' perception of an options price, hit a 10-year low last week.

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What does this imply? It means that making directional bets on the EEM ETF using options has never been cheaper as a percentage of the ETF price. For instance, one could acquire September $43 calls for around $1.25/contract ($125 total per contract), representing approximately 3% of the underlying asset's cost. If held until September expiration, EEM would need to surpass the $43 strike price by the $1.25 premium paid, levels unseen in two years.

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The subsequent six-month chart illustrates how the call option would perform in real-time. Managing the trade dynamically rather than waiting until expiration to adjust one's position makes the trade considerably more appealing.

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Whether emerging markets truly rebound or if the recent resurgence is merely a temporary "dead cat bounce" remains uncertain. However, purchasing a call for $1.25, even with some trade management involved, may present a lower-risk approach to participation if the rally persists compared to buying the EEM ETF outright after its recent $3.40 rally.

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