London/New York: Options traders are paying the most to protect against a drop in Chinese stocks since the depths of last year's global financial crisis as policymakers in Beijing take steps to cool economic growth.
The gap between the implied volatility of options betting on a decline in the iShares FTSE/Xinhua China 25 Index Fund and those that would profit from a gain widened to 7.4 on February 17, the biggest since March, and was 7 Friday, according to data compiled by Bloomberg. Implied volatility is a measure of expected stock swings and the key gauge of options prices.
The exchange-traded fund, which holds shares of Chinese companies and trades on US bourses, has dropped 15 per cent from its 2009 high on November 16 as the People's Bank of China ordered lenders to set aside larger reserves in a bid to cool inflation in the fastest-growing major economy. Investors are also concerned that China may let its currency strengthen, making exporters less competitive, according to AlphaShares.
"There's a lot of anxiety about how policy makers keep increasing the reserve ratio for banks and what a strengthening yuan would do to the giant export machine," said Jonathan Masse, who helps oversee about $480 million (Dh1.7 billion) in Chinese stocks at Walnut Creek, California-based AlphaShares, the fund company co-founded by Princeton University economist Burton Malkiel.
The China 25 Index ETF tumbled 1.7 per cent to $39.03 in New York trading after the Federal Reserve unexpectedly raised its discount rate Thursday, heightening concern that tighter monetary policy around the world will slow the global economic recovery.
Open interest
Options granting the right to sell the ETF in three months for 10 per cent below current prices have a so-called implied volatility of 35.58, compared with 28.59 for the equivalent options to buy, Bloomberg data show. The last time the gap was this wide, global equities were falling to six-year lows on concern bank losses would spur a repeat of the Great Depression. The ETF's most-traded option Friday was a put giving the right to sell shares at $35 by May 21. Options linked to the ETF had the 27th highest volume last year for all indexes and equities, according to data from the Options Clearing Corp.
The open interest, or number of existing contracts, for all puts has risen 6.2 per cent in the last week to 1.45 million, the highest level since November. Open interest for call options giving the right to purchase the ETF has increased 3.9 per cent to 674,184.
"There's been outsized demand for downside puts," said Justin Golden, a strategist at New York-based Macro Risk Advisors, which advises institutions on equity derivatives. "This is related to a heightened degree of uncertainty around the speed at which China will tighten policy in addition to the potential for a currency revaluation at some point in the near future."
China's central bank said on February 12 that it will lift reserve requirements for banks for the second time this year on February 25. Policymakers are reining in credit growth after banks extended 19 per cent of this year's 7.5 trillion yuan (Dh4.02 trillion) lending target in January and property prices climbed the most in 21 months.
China may let its currency appreciate by 5 per cent as early as next month to prevent economic growth from stoking inflation, Stephen Jen of BlueGold Capital Management said in an interview last week.
