The main China stock etf (FXI) is now up ~ 25% from the April lows and is now just below the highs from October and March. Since September we have now seen FXI have five moves of ~ 24% or more with 3 sharp rallies and two significant declines/pullbacks. What stands out to me currently, on the heels of the 25% rally in just the last 6 weeks, is how “cheap” 3-month (Aug) puts are trading. Even with 60-day realized vol trading ~ 40, the 3-month 25-delta puts are currently trading ~ 27, which is near the one-year lows in terms of implied vol. As we know, the China equity market can (and has) seen sentiment turn VERY quickly. Therefore, you want to be considering hedges/insurance when vol is this low and after we have seen a sharp rally (as we have just had). What I especially like about owning August options here is that not only does that allow for a significant time for the hedge to “work”, but the current 90-day pause on tariffs is slated to end on Aug 12th (3 days before the August options are set to expire). This dynamic is very important, in my opinion, as that looming “pause” end-date of 8/12 should keep a bid to vol for August puts (why I want to consider buying them now).
On the fundamental side, 22V China’s team (Michael Hirson and Houze Song), had this to say about potential risks to the stock rally:
The hedge for equities lines up with our view that risks around trade and China’s stimulus in coming months are tilted to the downside, as argued in our recent update on China’s outlook (link HERE).
The key factors are as follows:
- Trade truce risks: Our base case is that the US and China avoid tariff re-escalation when their truce from Geneva runs out on August 12. However, there is a substantial (30%) probability of re-escalation, and likely to be significant noise and related volatility as the deadline approaches.
- China stimulus risks: Investors will be watching closely for fiscal stimulus announcements around China’s end-July quarterly Politburo meeting on the economy. For reasons discussed in our recent note, stimulus could disappoint both in terms of timing (we now think late Q3/early Q4 is more likely than July) and in terms of scale (we think the size of stimulus will be modest).
Trade:
Buy FXI August 34 puts for ~ .92 (FXI 36.35 ref)
Trade Details:
- Buying the August 6.5% (28-delta) downside puts following sharp rally off the April lows
- 3-month (Aug) vol now trading just above the recent lows and at a significant discount to 60-day realized vol
- August expiration will capture the key economic meeting at end of July that Michael Hirson mentioned above, as well as thru the current August 12th truce deadline
- FXI has now had five large moves just since September. Want to pick spots after sharp rallies to add low-cost hedges
- Puts can be bought to hedge long China equity exposure, or as a limited-risk bearish bet given favorable price/vol setup
- Please reach out to me or the 22v sales desk for updated pricing and execution capabilities
FXI has now had five moves of ~ 25% or more just since September (3 sharp rallies and 2 significant declines)
FXI 3-month (August) 25-delta put vol now trading just above the recent lows and at a large discount to 60-day realized vol
