Sizing up the options for emerging markets ETF, EEM

Thanks to one of my trading buddies for sharing some info on a huge put trade being placed onto EEM! That involved one trade of 55,000 June 25 puts, bought at $1.16, against open interest of just 20,614. This indicates new positions, though less than the 20-day average overall volume but triple the average for June strikes. It also places the June expiration put/call ratio at 47, with this one trade constituting virtually all the volume for this month. Sure - it's possible this can be one very large hedge against a large long position, and therefore not necessarily a bearish signal for this exchange-traded fund. It would calculate to 1-1 protection on approximately $152 million as measured by the price of the EEM shares. Let's take a look at what the charts may be saying.

First, the daily chart shows EEM nudging up to the 200-day moving average - a classic resistance level. If surmounted then it can become support, but the first assumption must be to expect turbulence at best, and a barrier at worst that could tumble EEM to re-test its November 2008 or March 2009 lows. Volumes have been better on recent up days than recent down days, but looking at the weekly chart, the volumes have been declining as the rally has continued, so rally fuel may be dwindling. On the bigger picture, monthly chart, I can count five waves up and - so far - three waves down. The monthly chart pattern can be interpreted as a trap door to go long after a capitulation low, although better volumes on the rise would be more encouraging - and on this chart pattern, it's imperative that EEM remain above the March 2009 $20 low.

All in all, it looks reasonable for anyone with a substantial long position to put on a substantial hedge, certainly into the 200-day moving average. If it does drop, then the 20-day and 50-day moving averages should be logical levels to look for support. $25 is about in the middle of where those averages stand today - which may have played into the put buyer's strike choice. If it turns out that the Elliott Wave places EEM in a large 4th wave upward correction, and the next move is a 5th wave down (just speculation right now!), then put buyers will reap additional rewards. A good reason to keep an eye on the $20 level too.