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Buy Taiwan Options as China Trade, Tourism Ties Surge, Morgan Stanley Says

Investors should buy bullish options on Taiwan’s benchmark stock index because it will extend gains as Chinese trade and tourism increase and rising technology sales boost corporate profits, Morgan Stanley said.

Viktor Hjort, a Hong Kong-based strategist, recommended buying over-the-counter Taiex Index call options which expire in March and have a strike price 5 percent above the current index level. The index of 721 companies traded on the Taiwan Stock Exchange rose 3.8 percent last week to 8,624.01, the highest since June 2008.

The Taiex may surge to 10,000 next year as improved relations with China boost tourism and lifts the island’s technology sales, Morgan Stanley analysts led by Frank A.Y. Wang wrote in a Dec. 3 report. Technology companies, which account for 46 percent of the benchmark’s market value, will rally as global companies increase equipment purchases, Hjort wrote in a separate report.

“More cross-strait trade policies with China, the global tech upgrade cycle in 2011 and implied volatility around multi- year lows favor call options as the index is at multi-year highs,” Hjort wrote. “With improved balance sheets and earnings quality we also expect 2011 to be the main phase of the recovery leading to a positive earnings upgrade cycle ahead driven by tech.”

Implied volatility, the key gauge of option prices, for three-month options 5 percent above the index level fell 7.1 percent to 15.20 on the Taiwan Futures Exchange last week, down from this year’s peak of 25.02 in May, according to Bloomberg data. It dropped to a three-year low of 14.63 in September.

Calls, Puts

Investors who want to make a longer bullish trade and eliminate the cost of the transaction should buy an October call that’s 5 percent above the index while selling an October put that’s 17 percent below, Hjort said. The put’s strike is about the same as Wang’s “bear case” level to which stocks may slide, the report said.

Calls give the right to buy a security for a certain amount, the strike price, by a set date. Puts give the right to sell. Selling a put is a bet that the underlying security will remain above the strike price, allowing the seller to keep the premium paid.

The Taiex rose 0.9 percent to 8,699.83 at 9:53 a.m. local time, adding to a 6.2 percent advance this year, after jumping 78 percent in 2009 as Taiwan’s President Ma Ying-jeou helped cement closer ties with China by abandoning his predecessor’s pro-independence stance. The government has signed 14 agreements with the mainland since Ma took office.

China Tourists

Mainland visitors are expected to be the biggest source of arrivals for the first time this year, surpassing the 1 million projected for Japanese visitors, Chang Shi-chung, chief secretary at Taiwan’s Tourism Bureau, said Nov. 23. Taiwan expects foreign tourist numbers to climb to 6 million next year from 5.4 million this year, the Cabinet said in a statement on its website Nov. 30.

Taiwan’s stocks were also raised to “bullish” from “bearish” at Nomura Holdings Inc. today, which cited better global growth prospects. The brokerage also said the Taiex offers “significant potential upside” and favored financial companies, technology brands, lower valued notebook computer makers and tourism- related companies.

To contact the reporter on this story: Jeff Kearns in New York at jkearns3@bloomberg.net.

To contact the editor responsible for this story: Nick Baker at nbaker7@bloomberg.net.

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