A few years ago, it was SARS (Severe Acute Respiratory Syndrome). Then came bird flu, which spread throughout Asia.

Now, several parts of the world are in the grips of another nasty disease – this time, born in Mexico: Swine flu. 

Unsurprisingly, Mexican stocks are taking a hit as the death toll from the disease increases – just as Asian shares got hammered as the SARS and bird flu outbreaks ran wild in the various countries. 

For example, stock shares of Mexican telecom giant Telefonos de Mexico (NYSE: TMX) got slammed, as investors worried about the impact that the flu may have on companies. 

This is a perfect example of mass selling with no basis in logic. In fact, Telmex reported today that its customers have actually used the company’s services more over the past few days, as people decided to use the phone instead of going outdoors and risking infection. 

Looking back, the long-term effects of SARS and bird flu were muted. From an investment standpoint, the plays offered – vaccine companies, mask manufacturers, etc. – proved to be short-term bets that didn’t work. 

So what lessons can we apply from SARS and bird flu to the current swine flu news?
 

Mexican Stocks – Attractive Valuations & Opportunities 

I’m not outright advocating a “buy” on Mexican stocks today… or even tomorrow. After all, the global economic contraction is a much bigger story. 

However, if an investment opportunity presents itself, then we should be ready to act. And with swine flu, the news may get much worse in the short-term. That means we could have a chance to pick up shares or buy long-term options at very attractive valuations. 

It’s essentially the potential “double whammy trade:” An already weak Mexican market is further weakened by an unexpected event, whose duration and final impact will likely not be as serious as many think. 

Suffering Sectors Can Provide The Best Profits 

In the aftermath of the SARS and bird flu events, the sectors that suffered the most – airlines and hotels, for example – turned out to be excellent short-term trades that made many people a lot of money. 

So if the Mexican market – and even U.S. airline shares – continues to get hammered, you should seriously consider putting on a low risk trade. 

Note: By “low risk,” I’m suggesting that you execute a trade that allows you to benefit from both an eventual recovery in share price, and do so while risking very little capital, compared to what you’d invest if you bought the shares outright. 

The answer lies in LEAPS options…
 

Take Advantage Of Mexican Stocks With LEAPS 

LEAPS are longer-term options, with a duration of one year or more. They’re available on Mexican stocks like Telmex (which only date to January 2010 at the moment, but new options should be issued shortly) and U.S. airline shares. 

You can usually purchase LEAP options with an at-the-money strike price (close to the current share price) for 10% to 20% of the underlying share price. 

For example, with Telmex shares currently trading around $16, you can buy the $17.5o call options expiring in January 2010 for $1.50 per contract. This means you have less money at risk than if you buy the shares outright. 

• Let’s say the swine flu outbreak gets worse and TMX drops to $12 or $13.  
• At that point, the $12.50 strike LEAPS would be trading for $1.30 or thereabouts. 
• A move back up to pre-swine flu levels would take the shares up to the $17 level – a $5 move in the share price and a return of about 40%. Pretty good. 

But the LEAP options would move to $6 or so – the same $5 move, but a return measured in triple-digits. And you achieve this while risking less than 15% of the capital you had at risk if you bought the shares. 

Remember… this is a trade, not a long-term investment. But sometimes, especially when there are events that warrant it, it makes more sense to engage in low-risk; high return trades like this. 

Karim Rahemtulla
Smart Profits Report