Hong Kong Confidence Builds as Stock Hedges Get Cheaper

For Hong Kong options traders, the stock rally has room to run.

Puts with an exercise price 10 percent below the benchmark Hang Seng Index cost 2.8 points more than calls betting on a 10 percent increase, according to three-month data compiled by Bloomberg. The price relationship, known as skew, is 15 percent below the average this year and fell to 0.2 point on July 30, the lowest since November 2012, the data show. The stock gauge jumped 6.8 percent in July, the biggest monthly advance since September 2012 and the most among developed markets.

Investors are betting that low valuations for the city’s stocks and a government plan to link its bourse with Shanghai will drive further gains. Policy makers will allow overseas investors to trade Chinese shares through Hong Kong and wealthy mainlanders to buy the city’s stocks. A similar 2007 proposal, later scrapped, helped push the Hang Seng Index to a record.

“There’s more upside for Hong Kong shares as they’re still trading at a discount to regional markets,” Pauline Dan, who helps oversee $153 billion as Hong Kong-based head of greater China equities at Pictet Asset Management Ltd., said by phone on Aug. 4. “Hong Kong has been a laggard in the global market rally and it’s starting to see fresh inflows. The proposed trading link with Shanghai solidifies Hong Kong’s position as China’s financial center.”

Relative Value

Shares on the Hang Seng Index were valued 11.4 times estimated earnings yesterday, compared with a multiple of 8.8 times for the Shanghai Composite Index, 13.5 times for the MSCI Asia Pacific Index and 16.1 for the Standard & Poor’s 500 Index, according to data compiled by Bloomberg.

The city’s monetary authority bought $8.39 billion in July, the most since at least October 2012, to defend its currency peg as share listings, dividends and mergers and acquisitions spurred demand for Hong Kong dollars.

The July stock rally was tempered on Aug. 1 amid a global selloff, when the city’s benchmark index fell 0.9 percent, the most in three weeks. The measure rose 0.2 percent yesterday, the 10th advance in 11 days.

Investors are beginning to appreciate that many Chinese shares are undervalued, Tim Schroeders, a portfolio manager who helps oversee $1 billion in equities at Pengana Capital Ltd. in Melbourne, said by phone on Aug. 1.

China Appreciation

“Growing confidence in the Chinese economy has helped boost shares in Hong Kong,” Schroeders said. “Hong Kong is benefiting from increasing demand for Chinese shares. Initially, there was concern before that Hong Kong will lose its significance as a financial hub in the region as China opens up its financial market. Clearly, the move to embrace Hong Kong as part of that transition is positive for both Hong Kong and China.”

China’s manufacturing expanded in July at the fastest pace in more than two years, signaling a pickup in growth amid government support. Signs that Asia’s biggest economy is improving pushed the Hang Seng China Enterprises Index of mainland shares traded in Hong Kong into a bull market last week, having surged more than 20 percent from an eight-month low on March 20.

“China just emerged from a downturn and we don’t know if the improvement is sustainable,” Francis Lun, Hong Kong-based chief executive officer at Geo Securities Ltd., said by phone on Aug. 4. “People have enormous optimism on the Hong Kong-Shanghai connect, and that’s already over done.”

Bourse Shares

Hong Kong Exchanges & Clearing Ltd., the world’s largest bourse operator by market value, posted the second-biggest advance among the 50 stocks on the Hang Seng Index this year through yesterday, with most of the gains coming since Chinese Premier Li Keqiang on April 10 announced plans for the equity link.

Calls that profit should the city’s bourse operator advance 10 percent cost 5.8 points more than puts hedging against a 10 percent decline, according to three-month data compiled by Bloomberg. The price difference climbed to 6 on Aug. 1, the highest since February 2011. Lorraine Chan, a spokeswoman for the bourse operator, declined to comment on the options trading. Hong Kong Exchanges said today profit improved in the first half as initial public offerings surged.

“The performance of HKEx can be used as a mimic for the Hang Seng Index,” Castor Pang, head of research at Core Pacific-Yamaichi in Hong Kong, said by phone on July 31. “Investors believe that overall market turnover will increase substantially after the Shanghai link starts in October.”

The HSI Volatility Index, which tracks the cost of options on Hong Kong’s Hang Seng Index, rose 0.4 percent to 15.74 today. The Chicago Board Options Exchange Volatility Index, or the VIX, jumped 12 percent to 16.87 yesterday.

Most-Owned Options

Four of the five most-owned contracts on the Hang Seng Index were bullish calls, according to data compiled by Bloomberg. Investors poured $413.4 million into the iShares MSCI Hong Kong exchange-traded fund in July, the most since October 2012, after withdrawing funds in the first five months of the year.

“The rally will continue,” Ben Kwong, a director at KGI Asia Ltd. in Hong Kong, said by phone on Aug. 4. “There’s still positive sentiment on the Shanghai-Hong Kong stock connect. That will boost trading volume and attract more funds flowing in.”

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