'Lottery' trading finds support in battered Chinese stocks

Amid the devastation of China's stock market crash, some traders are making big bets that authorities in Beijing can spur an economic recovery.

They see an opportunity to target options tied to U.S. exchange-traded funds (ETFs) that track Chinese stocks, which have been disrupted by coronavirus lockdowns, regulatory pressures and the real estate crisis. This comes as market participants, who have seen stocks from Beijing to Hong Kong fall 60% from their 2021 peaks, are looking to buy stocks on the upside in case the government ultimately succeeds in spurring a recovery. This is proof that you are thinking about grabbing it.

“You're just buying a cheap lottery ticket with the promise of a big payout,” said Charlie McElligott, managing director at Nomura Securities International. The worse the situation for Chinese stocks, he said, “the more attractive they become from a risk-reward perspective.”

Chinese leaders want to stop the stock market from falling, and betting on ETF options is evidence that at least a small number of investors are paying attention. Even though most traders are unable to buy stocks outright and actively avoid them, options offer a way to maximize profits while minimizing potential losses.

Additionally, US-based ETFs are trading while some local financial markets are closed for the Lunar New Year holiday.

Chinese stocks have been the world's worst performer in the past three years as prolonged coronavirus lockdowns, regulatory crackdowns in sectors such as technology and education, and a rampant real estate crisis undermine investor confidence. . The mainland stock index listed in Hong Kong has fallen nearly 7% this year alone, but the index rose 1.5% after the Lunar New Year on Wednesday.

bullish bet

Call option trading volume in the $4.2 billion iShares China Large Cap ETF, known as FXI, which typically indicates investor interest in making bullish bets on an asset, surged last week to its highest level in more than a year. It became. Similar trends have emerged in recent weeks across the $20 billion China-focused U.S.-listed ETF market, driven at least in part by traders fearing missing out on a potential recovery. There is.

President Xi Jinping's government has pushed to curb domestic short selling, opted for state purchases of the nation's largest bank stocks, and even replaced the top securities regulator, spurring an increase in options trading. There is. The government also said it was buying up shares in domestically listed ETFs.

Call option volume has receded during the year-end lull, but traders are still on the lookout for the next catalyst for stock price gains, even as overall investor sentiment remains deteriorating. That's what I'm aiming for. At times, the Chinese government's stimulus pledges have produced short-term market gains. FXI rose 4.4% last week following the latest round of measures, but is still down 5.7% since the start of the year.

Timing your trade

As risks such as the U.S. presidential election become longer-term, purchases of short-term contracts increased the most. Of the 10 FXI contracts with the largest open interest, nine are calls expiring in February and March, allowing holders to buy shares between $22 and $30.

For example, Evercore ISI recommended that clients buy FXI call options expiring on March 28 to take advantage of low valuations in Chinese stocks. This gives traders a way to bet on further economic stimulus between now and March, when the Chinese government convenes the National People's Congress. Goldman Sachs Group Inc. also touts options trading on Chinese assets.

“Call options are a great way to approach this topic because they're not expensive on a volatility basis,” said Julien Emanuel, senior managing director of equities, derivatives and quantitative strategies at Evercore. “The risk is limited, but the reward is theoretically unlimited.”

But memories of strained U.S.-China relations under former President Donald Trump are discouraging bets close to the U.S. presidential election.

In another closely tracked metric, FXI's one-month put-to-call skew has reversed several times in recent weeks, with options betting on upside costing more than bearish contracts. Lin Zhou, head of equity derivatives strategy at TD Cowen, said this is a sign that traders are using options to try to bounce back.

He noted that the cost of FXI's 1-year options is trading at a 10-year high compared to the cost of SPDR S&P 500 ETF Trust, with traders bracing for significant swings in Chinese stocks over the coming year. I anticipate that it will be necessary. Track the S&P 500.

“Purchasing call options is a way to get exposure without committing a lot of money,” said Malcolm Dawson, head of emerging markets strategy at Global X Management.

© 2024 Bloomberg