The Russian stock ETF, RSX, is back near the lows of the past 3 years after the severe emerging market selloff of the past month. RSX is close to where we initiated a relief rally trade that was a decent winner back then, nearly at the level of the March lows:
Even on a risk-on day globally like today, RSX is having trouble bouncing. The main reason for that is that the etf is still exposed to the Russian ruble, which is hitting another new low vs. the dollar this morning on the back of general dollar strength:
Since the March lows, the Russian ruble has lost around 9% against the U.S. dollar. As a result, RSX would be nearly 10% higher (or around $24) since March if it were not for the currency impact.
Emerging market stocks and currencies as a whole have been battered. We detailed the high velocity selloffs in Russia, Brazil, and Hong Kong in a MorningWord post on Tuesday. We noted the main risk in Russia remains political:
Even though valuations are extremely cheap for Russian stocks, the political risks of confiscation and further conflict are serious and real.
However, the one major benefit of the extremely cheap valuations in Russia is that even if many of the market fears come to pass, stocks still might not have much downside. At the current valuation, the market seems to be pricing in a 50/50 chance that an investor in Russian stocks could get completely wiped out.
One global value investor I respect, Meb Faber, has discussed the risks in Russia that are reflected in the depressed valuation of Russian stocks. From a post in March:
Buying a value investment is hard for many reasons, a few of which I outline below with a very relevant current example, Russian stocks.
1. All of the headlines are negative.
2. The investment has declined, usually by A LOT.
3. All of the trailing fundamentals are really bad.
4. People can find many reasons why “this time is different” for the value metrics not to be reflective of the current situation.
5. There is a non-zero risk of the investment going to zero.
6. It is not popular (or patriotic) to own the investment.
7. Buying the investment, and it going down more, would pose serious career risk. (or divorce risk).
8. The banking consensus is all sell rated.
9. Flows are out.
Russia checks all of these boxes and then some.
In other words, the negatives are well known in this situation.
Given the headline risk, technical situation, and depressed valuation in the Russian market, I’m surprised that implied volatility is still below 30:
[caption id="attachment_46308" align="aligncenter" width="600" class=" "]
30 day implied volatility in RSX, courtesy of Bloomberg[/caption]
That is far below the levels from March and April when RSX was at a similar price.
In this context, I like the idea of buying a longer-dated at-the-money call in RSX to play for a bounce over the next 6-9 months. I’d rather go further out in expiration since implied volatility is not too elevated, and timing is difficult given the way the dollar is moving at the moment.
For example, the May 23 call is currently priced at $1.15 to $1.45, so you could probably buy it around $1.30. On the first relief rally in RSX, that position would likely be near a double. Since you have more than 6 months until expiration on that option, there is very little decay on the option over the next 3 months. The main risk is that RSX simply tumbles, but for all of the aforementioned reasons, the idea behind buying the call is that the risk of a tumble is lower than the risk of a significant rally from here.
With the dollar continuing its rapid ascent, I am going to wait on entering the position just yet. However, we will be watching RSX closely for a good entry point on this trade in the coming month.