Chinese Options Signal Stocks Not Yet Out of the Woods: Analysis

Last Trading Day of 2011China Stocks Rise, Paring Index's Biggest Annual Loss Since 2008
Photographer: Qilai Shen/Bloomberg

China equity option term structures have aggressively inverted over the past week and implied volatilities are edging closer to peaks seen during August rout, as yuan devaluation roils global markets, Bloomberg strategist Tanvir Sandhu writes.

Hang Seng China Enterprises Index, or HSCEI, one-month implied volatility is at 39, about 16 points above the low of December. The level is still below 47 touched on Sept. 7, which was the highest since August 2011.

China large-cap ETF one-month implied volatility is at 36, compared with 50 on August 24, highest since October 2011. 

Skew has moved more in favor of puts over the week. Comparison of January skew today versus one week ago: 25d skew -13.1 versus -7.3.

HSCEI has fallen 8.5 percent and Shanghai stock exchange composite index 8.06 percent over the past week.

Elevated volatility and skew levels like these usually gives room for investors who are caught short to buy call and sell put options at the same time (risk reversals), if concerned of a near-term rally.

Note: Tanvir Sandhu is an interest-rate and derivatives strategist who writes for First Word. The observations he makes are his own and are not intended as investment advice.

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