Navigating Volatility: Effective Options Strategies for China-Linked Stocks

On Tuesday, the Shanghai Composite Index dropped by 2.5%, and the Hang Seng Index fell by 3.67%.

Last Saturday, the Chinese government announced that it would introduce more fiscal stimulus measures to boost the economy, including issuing local government bonds, increasing fiscal spending, and implementing certain measures to support the real estate market. However, some investors felt disappointed due to the lack of key details regarding these planned measures, particularly concerning timing and scale, as well as clear initiatives to support personal consumption. Additionally, the rise in ten-year U.S. Treasury yields, new geopolitical conflicts, and China's weak export data in September also had a negative impact on Chinese assets.

The operational difficulties for China-linked stocks in the future are increasing.

UBS analysts have indicated that Chinese stocks may face heightened volatility in the near future as investors assess the government's latest stimulus measures. They also highlighted potential risks associated with a lackluster stimulus package.

“Investors remain highly sensitive to any policy signals, and stand ready to move quickly in response. If Beijing’s fiscal package falls short of expectations or if policymakers stay quiet in the coming weeks, we could see the market take another hit,” UBS analysts noted.

They expect Beijing to release more information on the planned fiscal measures in the coming days, especially given that any planned increases in government spending will have to be approved by the National People’s Congress, which likely convenes later in October.

On Monday evening, Caixin reported that China may issue an additional 60 billion yuan in government bonds over the next three years to boost the economy. It is said that part of this funding will be used to address local government debt.

Goldman Sachs economists anticipate an increase in quotas for ultra-long central government special bonds and a more extensive local government debt-swap program. However, they remain skeptical that policymakers will utilize ultra-long bonds for debt swaps, as Beijing has traditionally employed local government bonds for this purpose. The Ministry of Finance intends to provide local governments with additional bond quotas to address implicit debt. If this plan comes to fruition, Goldman Sachs would consider it a significant step by the central government to directly assume some local government debt, potentially alleviating near-term default risks for local government financing vehicles (LGFVs), while also raising concerns about moral hazard.

●2024 US elections

Trump's chances of winning the election have recently increased on betting sites, potentially negatively impacting Chinese assets. If re-elected, he has pledged to raise tariffs on foreign goods, with up to 20% on imports from other countries and 60% on Chinese imports. Goldman Sachs strategists predict that a 60% tariff could lead to a 13% decline in Chinese stocks.

Yeap Jun Rong, a market strategist at IG, notes in a commentary that specific fiscal policy commitments from China are likely to be delayed until after the U.S. elections. The outcome of the elections will influence trade relations with the U.S., and current economic data from China has yet to demonstrate the effectiveness of the policies announced in September. As a result, any policy commitments from China at this stage may be seen as premature. This lack of clarity could result in a prolonged period of consolidation for the Hang Seng Index. Yeap suggests that while the worst may be behind us, the benchmark index is expected to stabilize within a range of 20,400 to 21,600.

●US rate cut pace

Consumer prices in US increased by 2.4% in September compared to a year earlier, down from 2.5% in August, marking the smallest annual rise since February 2021. However, "core" prices, which exclude volatile food and energy costs, remained elevated, rising 3.3% year-over-year and 0.3% from August, driven by higher costs in medical care, clothing, auto insurance, and airline fares. Economists monitor core prices closely as they offer a clearer indication of future inflation trends.

The yield on the 10-year U.S. Treasury bond is near its highest level since early August, as stronger-than-expected economic data reduces the likelihood of significant Fed rate cuts. The market now sees an 82.2% chance of a 25 basis point cut in December, up from a 41.3% chance of a 50 basis point cut a month ago.

●Geopolitical risk

This is a risk faced by global markets, including the escalating conflict in the Middle East and the recent tensions between North and South Korea.

After the recent surge and pullback in Chinese assets, their volatility has declined but remains significantly above the average of the past year. Additionally, the pricing of calls is higher than that of puts.

Here, we take the options data of the two ETFs, KWEB and FXI, as an example, which does not constitute a trading recommendation or advice.

In this case, under the premise that Goldman Sachs remains overall bullish on Chinese assets, it is recommended to consider the following options strategies.

●If you remain bullish on Chinese assets, you might consider bull call spreads, such as buying a call with a strike price of 110% that expires in a few months and selling a call with the same expiration date at a strike price of 120%.

●If you currently hold the underlying Chinese assets, you might consider a collar strategy. For example, you could sell a call with a strike price of 120% while simultaneously buying a put with a strike price of 80% to hedge against the downside risk of the underlying assets you hold.

Aside from Goldman Sachs' strategies, if you are bearish on volatility and do not have a directional bias, the following are some potentially suitable options strategies: