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I am not trying to toot my own horn, but I definitely see a strong bull case for Japan, and called for year-end rally last week that is starting to take definitive shape.

I am not denying there's risk, especially with a big economic report due next week and key consumer and machinery data due this Friday and a week from now. But I think the reward highly outweighs the risk, with upside potentially above 16,500 for the Nikkei 225 and downside no lower than 15,500.

As I said earlier this morning and for disclosure purposes, I am trading iShares Japan ETF (NYSEARCA:EWJ) call options for December through March. Although I have over a 40% gain combined in less than a week, I am frustrated by the lack of liquidity in trading. Also, there is very little premium attached to call options with a $13 strike, where I initially bought. I am holding out for what I expect to be a breakout day today in Tokyo and will look at shifting my position some to different strike prices and expirations.

I do not have specific advice for how to play the rally I will provide support for below, although one way is by options, which I would be grateful! Another method, if you believe in the Japanese economy's "expansion" is to go long a Japan ETF. Roger Nusbaum (aka Random Roger) penned a piece on Japan ETFs today for TheStreet.com. It is an informative article, but of course I disagree with Roger's consistently negative take on Japan.

I have no comment on Wisdom Tree's Japan ETF offerings. I am a fan of dividends, but I'm not sure I merely like owning a broad fund that has thin trading volume. Of State Street's two new Japan ETFs, I am only interested in the Small Cap (NYSEARCA:JSC). I think there's a lot of opportunity here and as Roger said, and as I've said all along, it has been next to impossible for non-Japanese to play this segment.

Now, here are some key points to consider for a year-end rally (and beyond):

1. Due to the holiday last week and for whatever other reasons, Chicago N225 futures have lagged significantly behind those traded in Singapore and Osaka. That gap was effectively shut yesterday and now the Chicago NKZ6 (December contracts) are way ahead of the close in Osaka. This is huge because one of the first things the Japanese turn to in the morning, just a couple hours away, is Chicago. *Last NKZ6 pricing: +345.00 at 16,225.00, high of 16,225, open and low of 16,060. The N225 Stock Average closed Wednesday at 16,076 and the December futures at 16,100.

2. Another priority on Japanese investors/traders' minds is how the U.S. market fared and of course, how ADRs did. Well, with a near 1% gain for the S&P 500 and about 0.8% each for Nasdaq and Dow, things look good. The key of course is the positive GDP report this morning, which bodes extremely well for Japanese stocks, and especially exporters, because everyone is concerned about a slowing U.S. economy.

ADRs meanwhile, have done quite well in today's trading. As about 3:30pm nearly all the NYSE and Nasdaq listed issues were trading above their ordinary share equivalent closes -- this is a positive signal and should prompt buying of ordinary shares. The most ambitious buying could be for NIS Group (NIS) and Mizuho (NYSE:MFG), both of which are trading at a premium to their ordinary listing. ORIX (NYSE:IX) is the only issue I'm aware of that is trading at a discount to its ordinary listing.

3. The Nikkei Shimbun reported last week that year-to-date cash inflows into the Japanese stock market are the lowest in four years. It is not a surprise why, after the scandals early in the year and then the global correction from May. Plus, if you look around, neighboring markets are at multi-year and/or all-time highs such as in Shanghai, Hong Kong, South Korea and as far down as India.

One argument exists that hedge funds are toying with Japan, and there is the case that a large amount of buying could happen at any point. Why? Because the Japanese equity market is the second largest in the world and can absorb the inflow and not to mention its quality of issues. Particularly interesting are the mid-caps and some of the smaller-caps that offer compelling value after relentless selling. M&A remains robust and talk of TOBs, LBOs, MBOs and private-equity is a hot topic.

4. There's been a lot of discussion about the now notorious non-spending Japanese consumers. Well, despite the negative data, I don't believe it, or at least I don't accept it. First of all, one of the government's reports left out spending from online shopping and did not include services. Japanese reportedly spent online close to what the nation's fourth-largest department store took in sales in the last quarter. Also, Japan, especially in the metropolitan areas is a lively place with a lot of dining out, cafes, entertainment, etc.

While the wage growth hasn't been there, consumers are seen as ready to spend this winter as we head into the key Christmas and New Year shopping season. The Nintendo (OTCPK:NTDOY) Wii hasn't even launched yet (but will this weekend). And although I hate to blame the weather, it is the most often cited source of blame for recent consumer spending weakness. Higher spending on clothing could turn out to prove this theory.

5. Currency is not as big a concern as everyone is making it to be at this point. The yen did strengthen against the dollar earlier this week and has been stable since. One thing to consider is that a very large number of Japanese travel overseas during the holidays, and in turn exchange a lot of yen into foreign currency. I expect this, as it has in the past, to eventually be reflected in the forex market. Furthermore, until the yen/usd hits around the 110 mark, I wouldn't expect the market to punish exporters too much, or for too long. Remember, the yen faces downward pressure against the euro, against which it is trading near all-time lows.

6. I figured I ought to throw this in too: I read on Yahoo! Finance Japan that a hedge fund analyst said without the Nikkei 225 trading above its 25-day moving average (16,218), it will not be able to breakout of its current range bound trading. Based on the December futures at 16,225 in Chicago, we just might see that today in Tokyo, which should then prompt technical traders to jump in and short covering.

iShares MSCI Japan Index ETF (EWJ) 1-yr chart:

iShares-Japan-EWJ-1yr-chart-11-29-06

Disclosure: The author owns iShares Japan call options and a long position in NIS Group.

Source: Bullish on Japan -- Nikkei Primed for Big Rally