The biggest tumble in Chinese stocks since 2008 has done nothing to shake the resolve of bulls in the country’s options market, where bets on a rally have never been more popular.
Bullish wagers on the China 50 ETF have increased to the most expensive level versus bearish ones since the contracts’ debut in February marked the start of equity-linked options trading in China. The ETF, which holds some of the biggest stocks in Shanghai, has dropped 13 percent from its June 8 high after surging 133 percent in the previous 12 months.
Options traders are doubling down on bets that monetary stimulus and reforms by state-owned companies will keep the rally intact, undeterred by strategists who say China’s equity market is a bubble poised to burst. The benchmark Shanghai Composite Index gained 2.2 percent on Tuesday, rebounding from an intraday plunge that sent share prices to one-month lows.
“Investors are using call options to make sure they won’t miss the boat should the market rebound strongly,” Li Jingyuan, general manager of the securities investment department at Shanghai Zhaoyi Asset Management, said by phone on Tuesday. “Their belief in the foundations of the bull market, such as government reforms and loose monetary policies, isn’t shaken.”
The China 50 ETF rose 1.4 percent on Wednesday, while the Shanghai Composite added 2.5 percent.
Options wagering on a 10 percent gain in the ETF over the next month cost 22 points more than those protecting against a 10 percent drop on Tuesday, according to data compiled by Bloomberg. The relationship known as skew has averaged 2.7 points since February.
More than 137,000 contracts on the ETF changed hands, with traders holding 1.8 bullish calls for every put. The 13 most-popular options, based on the number of outstanding contracts, are all calls with strike prices higher than the last close.
That bullish stance contrasts with a chorus of warnings that the rally is unsustainable. Strategists at BlackRock Inc., Credit Suisse Group AG and Bank of America Corp. all said last week that Chinese equities are in a bubble, while the median stock on mainland exchanges is valued at 93 times earnings -- higher than when the market peaked in October 2007.
“There is an increasing gap between the perception of the market by domestic and international investors,” said Gerry Alfonso, a sales trader at Shenwan Hongyuan Group Co. in Shanghai, China’s second-biggest brokerage by market capitalization.
“While valuations in several sectors are high, given the perceived future strong demand, it is not unreasonable for some institutional investors to have a long position through options,” he said. “It might be a more convenient way to have exposure to the market if the rally continues, with perhaps less downside.”
The selloff in Chinese stocks, which sent the Shanghai Composite to a 13 percent drop last week, is a “healthy correction” that sets the stage for further gains, Steven Sun, the head of Hong Kong and China equity research at HSBC Holdings Plc, wrote in a report on Tuesday. Authorities will probably support the bull market given its role in helping state-run companies raise capital, according to Sun.
“It would be premature to call an end to this rally,” he wrote.
— With assistance by Shidong Zhang