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Options Signal Turning Tide in Emerging Markets

Emerging markets had few friends this year. Fears that monetary tightening would sap growth had investors pulling billions out of E.M. equity funds in the first quarter.

But in a sudden twist of sentiment, E.M. stocks rallied for 7 days, and options investors are setting up for more gains.

On Wednesday, an investor in the iShares MSCI Emerging Markets Index bought 10,000 July 54/58 call spreads, positioning for near-term upside in the shares.

Earlier this week, an investor rolled 100,000 call spreads to May at higher strike prices, another bullish move.

"In the last couple of weeks, many central banks have increased liquidity in order to cushion themselves from the economic ramifications of the Japan crises," said Jim Iuorio, TJM Institutional Services Director. "This extra cash tends to work itself into different spots and emerging markets is fairly high on this list." (*Note: Japan Rattled by Major Quake; Stocks, Dollar and Oil Fall)

Iuorio is long the ETF for this reason, he noted.

Add to that liquidity the improving fundamentals in E.M. nations, which seem to have tamed inflation worries with measured rate hikes, and options traders are betting this trend is far from over. Institutions, they note, are allocating to E.M. thanks to the clearer growth picture.

The beginnings of a turning tide for E.M. could be seen in the $2.6 billion in inflows during the last week of Q1, the largest inflows in EM equity funds since January.

That's a major shift from the $25 billion pulled from EM stock funds last quarter, according to EPFR.

Emerging markets stocks are up 15% over the past year, and with a 5% rally in 7 days, there's no telling where they'll stop.

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