One trader uses a risky maneuver to try to make $10 million on emerging markets

One trader sees the emerging markets continuing their rally and stands to make millions should his predictions come true.

Mike Khouw of Optimize Advisors told CNBC's "Fast Money" on Thursday he spotted "one of the largest trades we've seen" in the emerging markets ETF (EEM) earlier that day.

The trader sold 100,000 October 34.50-strike puts, bought the same number of October 37-strike calls, and then sold the same number of the October 38-strike calls, thus creating a trade known as a "call spread risk reversal" for no net cost.

This complex trade stands to earn the trader a huge sum if the EEM rises, but in return, risks a great deal.

By selling the October 34.50-strike put, the trader has agreed to grant the right to sell EEM shares for $34.50, even if they fall far below that level. Since any ETF could theoretically fall to $0, and each options contract represents 100 shares, this means that $34.50 x 100,000 x 100 is on the line — or $345 million.

Meanwhile, the point of maximum profits is at $38. If the ETF closes at or above this level on October expiration, the trader will get to pocket the difference between the strike of the call purchased and the strike of the call sold, or $1. Since this $1 is pocketed 100 times per contract, and 100,000 contracts were traded, the trader stands to make a $10 million profit — so long as EEM rises 3.5 percent or more off of Thursday's closing price.

On the downside, the trader doesn't see losses until EEM falls more than 6 percent below Thursday's closing price — and won't lose the same $10 million set to be made unless the ETF falls about 9 percent.

Of course, this is only possible because the downside risk is so much greater than the upside opportunity.

EEM, which generally tracks the S&P 500 but with greater volatility, is currently up more 13 percent in 2016.

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  • Melissa Lee

    Melissa Lee is the host of CNBC's “Fast Money” and “Options Action.”

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