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Option Trades in China ETFs Swing From Gain to $100 Million Loss

AInvestFriday, Jan 10, 2025 5:52 pm ET
2min read



In the volatile world of financial markets, fortunes can change rapidly. This was evident in the recent reversal of fortunes for traders in China ETF options, who saw their paper profits of over $100 million evaporate in a matter of weeks. The shift in sentiment towards Chinese companies and a decrease in implied volatility contributed to this dramatic turn of events.

The story began in early December 2023, when traders took advantage of a slump in bullish sentiment towards Chinese companies to place contrarian upside bets on a pair of tiny China-linked ETFs. They picked up calls allowing the holder to buy 18 million shares of Direxion Daily FTSE China Bull 3x Shares (YINN) by January 2026 and acquired about 210,000 of the May $15 calls on the Direxion Daily CSI 300 China A Shares Bull 2x Shares. These trades appeared to be highly profitable, with the traders sitting on paper profits of over $100 million.

However, the tables turned in late January 2024, as the traders closed their positions at almost as big of a loss. The reversal of fortunes was driven by two primary factors: disappointing economic indicators and a decrease in implied volatility.

Firstly, investors who initially had a positive outlook on China's economic recovery were largely disappointed due to softening economic indicators. This led to a decline in bullish sentiment towards Chinese companies, causing the iShares MSCI China ETF (MCHI.O) and the iShares Trust-China Large-Cap ETF (FXI.P) to decline by 16% and 14% respectively from their January highs. Another China ETF, the KraneShares CSI China Internet ETF, also declined by 19% from its January high. This shift in sentiment contributed to the reversal of fortunes for traders who had previously bet on a robust economic recovery.

Secondly, the decrease in implied volatility for several Chinese ETFs made options a relatively cheaper means to leverage upside potential in China. However, this decrease in implied volatility also made it more challenging for traders to profit from their bullish options trades, as the potential for significant price movements decreased. This factor, combined with the disappointing economic indicators, led to the traders' paper profits turning into significant losses.

The recent surge in bullish options trades on US-listed Chinese ETFs reflects investors' contrarian approach amid a slump in bullish sentiment towards Chinese companies. Despite the moderated level of positive sentiment, investors are actively seeking opportunities to position themselves for potential upside in Chinese ETFs. However, the recent reversal of fortunes serves as a reminder of the volatile nature of financial markets and the importance of staying informed about economic indicators and market trends.

As the Chinese A-share market continues to evolve, investors and traders must remain vigilant and adapt to the changing landscape. The interconnectedness of financial assets through ETFs and other investment vehicles can provide new channels for risk contagion, making it crucial for investors to understand the potential implications of their trading decisions. By staying informed and maintaining a balanced perspective, investors can better navigate the complexities of the modern financial system and make more informed decisions about their investments.
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