Archive for February, 2013

Trade of the Day: The Ninja pairs trade

Tuesday, February 5th, 2013

Today’s trade idea is courtesy of the Japanese government who is “encouraging” its central bank to print money thus devaluing the currency. You can see from the chart of the Yen exchange-traded fund (FXY) how well this policy is working.

Since October, the yen has shed 17% of its value and is looking to sink further. The government’s intention behind devaluing its currency is to stimulate its moribund economy by making Japanese products more globally competitive. Has it worked? Have you checked out the stock charts and read the recent earnings reports of some of the major multi-national Japanese companies lately?

If so, you’ll see that many of them have been soaring. Check out the daily charts of Toyota (TM) and Sony (SNE) below. (I selected these purely because they’re two of the most iconic Japanese brands.) The charts of many other Japanese multi-nationals paint a similar picture.

The trade is based on a simple concept: A falling yen boosts the share prices of Japanese multi-nationals. The idea of the trade is to go long a Japanese multi-national (or a basket of them) and short the Yen. A short position on the Yen can be accomplished by shorting FXY stock or buying FXY put options. Thankfully, FXY options are fairly liquid. While we’re on the subject of options, you could also take the long side of your stock trade by buying a call in place of stock. On the plus side, your cost of entry would be reduced but on the minus side, you’ll have only a fixed amount of time for this trade to mature. The trade-off in time versus money is a decision only you can make.

You will profit on both sides of the trade if the yen keeps falling but should it start to shoot up, be quick about closing out your positions. This pairs trade is double-edged sword.  You’ll have to be ready to pounce and book profits the minute the yen turns up before disappearing into the still of the night, just like a ninja.

To do this, you’ll have to stay on top of your positions. Especially, keep an eagle eye on the driver of the trade–the yen–as it nears support levels (shown in the chart above) and keep an ear out for any changes in the Bank of Japan’s (aka the BOJ) fiscal stance.  This will happen sooner or later as no (responsible) government will let its currency fall too far!

If you want to pick one stock as your long pair component, out of the two shown above I’d choose Toyota. In its most recent earnings statement, the company reported a quarterly profit increase of 23% and a sales increase of 9%. These figures were enough for it to reclaim its title of the world’s number one automaker. Even better, the company raised full year profit guidance from $8.5 billion to $9.3 billion, an increase of 9%.

Now, this pairs trade isn’t for everyone. If you’re a conservative investor who doesn’t have the time nor the inclination to monitor your portfolio on a daily basis, this trade is not for you. However, if you’re one of those folks who likes the concept of the trade but is uncomfortable taking the short side, at least consider taking the long side by adding a high quality Japanese multi-national to your portfolio. After decades of deflation and a declining Nikkei, isn’t about time that people started making money on the Japanese stock market and shouldn’t one of those folks be you?