$2 million bet on Japan

For past one month for obvious reasons Japan has been in the news. The triple whammy of an earthquake, tsunami and then the nuclear disaster at the fukushima plant has caused significant damage to Japans economy, on the order of $230 billion, according to some recent reports. Like any other major disaster, markets reacted to this bad news with a sell off. Nikkie fell by more than 6% on the first trading day in the aftermath of the earthquake.

Like many contrarian traders out there, I sense an investment opportunity here As a result, I have been on the look out for trading opportunity in Japan. In particular, I am following the iShares MSCI Japan Index fund EWJ. iShares says the following about EWJ “Fund seeks to provide investment results that correspond generally to the price and yield performance, before fees and expenses, of publicly traded securities in the Japanese market”. Perfect! There is no better way to play the Japanese markets as a whole. Dig deeper and you will notice EWJ is significantly invested in Japanese automarket, with approx 10% of the portfolio made up of Toyota and Honda. Neways, I will talk about the specifics of EWJ some other time.

I have been following EWJ for past 15 days now. Being optimistic about the situation in Japan in the long term, I am looking at LEAPS on EWJ. This is where the I noticed something very interesting yesterday. The last trade on Jan 13 call option with strike price of $12 happened at approximately 1 pm yesterday, and the volume of the trade per information on two brokerage accounts that I looked at, was 27000. The trade was made at 0.75 c per contract, which comes to about is approx $2 million for this trade. Some one has made a $2 million bet on Japan. This is a very interesting trade especially given that on the same day the volume on EWJ cal option with strike price of $11 was zero. Some one is either extremely optimistic on Japan or this is simply a glitch in the software; remember the mini market crash of last year.

Lets see what the upside of this trade will be under different circumstances. On the extreme optimistic side, lets say EWJ goes to $13 by end of this year. That is a gain of approx 30% in eight months. Simple calculations using Black Scholes model, tells me that the option will be priced at approx $1.7 per contract, which results in gain appro $2.7 million. Being less optimistic, but still optimistic, lets say instead of this year end, EWJ goes to $13 by fall of next year. In that case, very similar calculations produce a gain of approx $675,000, which is not bad either.

Should this be a call for going long on Japan!