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Morning Update

Yesterday as election results rolled in the S&P 500 futures sold off, hitting lows for the night as NBC announced Obama had won the election. After the news the futures rallied to test the 50-day moving average but the level was swiftly rejected as Mario Draghi said the European debt crisis was beginning to hurt Germany, Europe’s largest and most resilient economy. This caused traders to go into risk-off mode, with bonds catching a bid and equities across North America and Europe being sold.

As Americans took to the polls yesterday to choose the country’s new leader, China’s Politiburo Standing Committee is preparing for the 18th National Congress of the Chinese Community Party which will begin Thursday and result in a new ruling elite. Expectations are for Xi Jinping to be named party chief, effective next March. As a result there has been heavy options activity in FXI, the China 25 Index ETF. Yesterday one trader sold 19,875 Dec. 36.5 puts for $0.68 and bought 13,250 Dec. 38 calls for $1.02. The idea behind this spread is to gain long exposure to the FXI via long calls, but to offset the cost of buying those calls by selling puts. This spread was done for a net cost of zero, and will profit if FXI is above 38 at December expiration, which is in 44 days.

The bullish case for China centers around better than expected economic data released this month, and hopes that the leadership will tackle some of the many problems facing the country. China’s third quarter GDP was reported in line with estimates at 7.4%, but new estimates have been revised up from 7.4% to 8.1% growth in the fourth quarter and 9.0% in the first half of 2013. The catalyst for rising growth estimates has been China’s $1T+ stimulus in the past months. Some expect that when new leaders come to power following the National Congress more stimulus will be announced in order to maintain China’s rapid growth.

To play a pop in the FXI following the once in a decade National Congress this spread is worth considering. However, if FXI drops below 36.5, traders will be put the stock and must therefore be willing buyers there. To limit downside risk traders could forego selling a downside put, but this will move the trade’s upside breakeven higher, meaning a bigger move will be required to make a profit.

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