China Stock Rout Drives Cost to Bet on ETF Drop to Record High

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If U.S. investors thought it was difficult to make money from the boom in China’s stock market, they’re probably finding it even tougher to try to profit from a bust.

At the current cost to borrow shares of the biggest U.S. exchange-traded fund investing in mainland stocks, short sellers need the equivalent of a 40 percent annualized drop just to break even, according to Markit, a London-based research firm. The 28 percent plunge in the Shanghai Composite Index from its bull market high and volatility at the highest level in 18 years have made it more expensive than ever to profit from declines in the Deutsche X-trackers Harvest CSI 300 China A-Shares ETF as investors push bets against the fund to near a record.

“Only a handful of U.S.-traded stocks have such high costs for shorting,” Andrew Laird, a product specialist at Markit said by phone on Monday. “It has become very difficult to borrow this ETF, and there is virtually no supply left from the traditional custodian banks.”

The ETF sank 9.2 percent to $39.16 in New York on Monday, the biggest drop since July 8, as measure of historical 30-day price swings surged to a record 96 percent. The CBOE China ETF Volatility Index, a gauge of options prices, soared 26 percent to a two-week high of 38.51.

Traders pulled$401 million from the fund in the four weeks through Friday in the longest streak of outflows since it was created in November 2013. Investors withdrew from the ETF amid wide price fluctuations in mainland Chines stocks as the government implemented unprecedented intervention measures to stem a rout that wiped out about $4 trillion in market value.

Boom, Bust

Deutsche Bank AG spokeswoman Oksana Poltavets didn’t respond to an e-mail seeking comment on short selling in the $600 million ETF. The benchmark Shanghai Composite Index tumbled 8.5 percent on Monday, the worst one-day rout since February 2007, amid concern the measures to prop up the market are unsustainable.

The Shanghai Composite Index had rallied as much as 68 percent from this year’s low before it began a plunge into a bear market in June. An exchange link between Shanghai and Hong Kong gave overseas investors more access to mainland-Chinese shares, but U.S. traders were still limited on how much they could participate in the boom as government-imposed caps on foreign stock ownership.

The Shanghai measure fell 1 percent at the midday break.

Government Support

While volatility in Chinese stocks will continue, the government’s efforts to support the stock market will probably curb a more severe selloff, according to Brad Gastwirth at ABR Investment Strategy.

On a scale from 1 to 10, Markit rates the cost of shorting the ETF at the highest end. The annualized cost to borrow shares has been at a record 40 percent since July 22 and the most recent trades are going out at even higher rates, according to Markit’s Laird. Short interest in the Deutsche fund is at about 20 percent of outstanding shares, near a record 23 percent at the beginning of this month. Most of the trades were put on before cost to borrow jumped, according to Laird.

“People are still negative on the Chinese market,” Mohit Bajaj, director of ETF trading solutions at WallachBeth Capital, a New York-based brokerage firm, said by phone. As the costs have surged “it’s not really borrowable,” he said.

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