Take a look at this:
In less than two weeks, investors may learn more about China’s economy than at any other time since the coronavirus emerged from Wuhan to ravage the world economy.
The National People’s Congress is scheduled to meet May 22, and some investors are preparing for the possible release of economic stimulus measures during a gathering that typically lasts 10 days. China’s top legislative body was scheduled to meet March 5, but the coronavirus outbreak interfered with those plans.
Now, J.P. Morgan is telling clients to bullishly position in anticipation that Chinese stocks may rally higher in reaction to news of fiscal stimulus. The recommendation is sharply at odds with readings in the options market that indicate investor fear toward China has rarely been higher in the past decade, indicating that more investors are preparing for China’s stock market to decline than advance.
“Skew,” which is often used by investors to gauge the likelihood of a stock’s direction, is near a decade high for the iShares China Large-Cap ETF (ticker: FXI). The reading means that investors have bought loads of bearish puts on a leading China equity proxy in anticipation of a decline. When skew is at an extreme level, as it is now for options that expire in two months, it often means that investors are so scared that they are willing to pay any price to buy puts to hedge.
Yet, FXI did not decline as much as the S&P 500 Index since mid-March when it became evident that the coronavirus was a global pandemic. The proxies have tracked each other since late April, reinforcing J.P. Morgan’s controversial thesis to bullishly wager on China’s large-cap stocks at a time when so many others are concerned that the world’s second-largest economy is in rough shape.
Shawn Quigg, a J.P. Morgan derivatives strategist, advised his clients late last week that the odds of FXI’s trading lower might be limited. If the NPC moves to support the economy, and President Donald Trump proceeds with more trade talks, Chinese equities could bound higher. Quigg is so confident in this view that he has advised clients to take advantage of FXI’s elevated skew by selling puts and buying upside calls. When Quigg first proposed his trade, the ETF was at $38.20, and it has since inched higher.
With the ETF now around $39, investors can sell FXI’s June $35 put and buy the June $40 call for 27 cents. The “risk reversal”—selling a put and buying a call with a higher strike price but similar expiration—is often used to monetize investor fear and position for rallies. The strategy is a favorite of many investors when confronted with extreme fear as evidenced by expensive puts, and trading catalysts that could change opinions from bearish to bullish.
If the NPC announces measures to reopen the economy, or offers details about how the government will support the economy with stimulus, China’s stocks—and those of the world—may rally higher. Should the NPC fail to announce anything economically significant, the opposite could happen.
Anyone who considers J.P. Morgan’s trade must be willing to buy FXI at $35, which is the key risk. If FXI is at $45 at expiration, the call is worth $5.
During the past 52 weeks, FXI has ranged from $33.11 to $45.29. The ETF is down about 11% this year, compared with a 9% decline for the S&P 500 Index.
hmmmmmmm
