Speculator’s Corner: Chinese Consumer Spending

| December 3, 2012 | 0 Comments

YUMChina is one of the most intriguing investments around today.

The fundamental catalysts are easy to see…

They’re the second largest economy in world behind the US.  GDP is growing at better than 7%.  And they have a huge and growing consumer base. 

It’s no wonder so many investors turn to China in search of hot growth stocks.

Yet, investing in China has been like running a gauntlet despite the promising fundamentals.

Many investors are questioning China’s ability to maintain GDP growth at their targeted 7% per year growth rate. 

What’s more, wide spread accusations of fraud among smaller Chinese companies have tripped up stocks of China-based companies.  These companies gained access to the US markets through a process called a reverse merger.

Over the last year or so, the SEC has ratcheted up their scrutiny of Chinese companies that used reverse mergers to access US markets.  And it hasn’t been pretty… 

It’s gotten so bad lately that the SEC has accused the Chinese affiliates of the Big Four accounting firms of blocking their probe into the accuracy of financial documents of China-based companies listed on US exchanges.

Obviously, that’s troubling news…   

Don’t get me wrong, there are plenty of Chinese companies that are on the up and up.  But a few bad apples have made investing in China much more difficult. 

Luckily, there’s a way to invest in the Chinese growth story without ever owning a Chinese stock.

US based multi-national corporations with large exposure to China are an easy way to get the benefits of the fast paced Chinese economy without the added risk of investing directly in China-based companies.

For instance, Yum! Brands (YUM) has made huge investments in China over the last few years.  The performance of the stock is now almost solely tied to the success or failure of their brands in the Chinese market. 

So far it’s been a huge success.  The stock has soared more than 30% over the last two years.  A feat that’s even more impressive when you consider the iShares FTSE China 25 Index Fund (FXI) has fallen 17% over that same time.  

Lately, US based companies have been feeling the pinch of the slowing Chinese economy.  And have been forced to dial back their growth estimates for 2013.

Just last week, YUM said they expected same store sales in China to fall by 4% in the fourth quarter.  Not surprisingly, the weaker than expected guidance knocked YUM down 10%.

If you believe in China’s long term growth potential, YUM’s pullback creates an interesting opportunity to speculate on the consumer spending in China.

At this point, it looks like China’s slowing economy will put downward pressure on stocks with exposure to the Chinese consumer in the short run.  But growth should rebound in the long run.

Selling put options on YUM is a great way to position yourself to buy YUM stock at a lower price and be in position to profit from a rebound in growth longer term.

Here’s how it works…

Let’s say you want to buy 100 shares of YUM.  Right now it’s trading for about $67.15 per share.  But we’d rather pay around $60 per share.

By selling the YUM $60 July 2013 put for $3.00, you will immediately collect $300 in option premium. 

If YUM falls below $60 before the option expires in July, you’ll be assigned 100 shares of YUM at $60 apiece or $6,000.  But don’t forget, you already collected $300 in option premium when you sold the options.  So your total cost to buy 100 shares of YUM is only $5,700 or $57 per share.

However, if YUM doesn’t fall below $60, you won’t get the shares.  But you’ll still get to keep the $300 in option premium you collected when you sold the option.  So at least you’re getting paid to wait for the stock to fall to the price you want to pay.

As you can see, selling out-of-the-money put options in YUM is a simple way to buy the stock at a lower price.  And if it the stock doesn’t fall, you still make money.  That’s a win-win in my book.

Good Investing,

Corey Williams

Tags: , ,

Category: Speculator's Corner

About the Author ()

A former banking executive, Corey Williams is the Chief Options Strategist and co-editor of our well-known daily newsletter, Options Trading Research. Corey’s extensive experience with options goes all the way back to his days in corporate finance. It was this decade in banking where Corey discovered the most important skill an options trader can have– the ability to analyze a company or sector to determine its likely future direction. And now he’s brought this background, experience and love of options to Options Trading Research, the unique daily e-letter devoted exclusively to helping individual investors profit from the very lucrative options market.