China Puts Showing No Faith in Predictions for Rebound: Options
September 08, 2011, 2:39 AM EDTBy Lynn Thomasson and Cecile Vannucci
Sept. 8 (Bloomberg) -- Options to protect against declines in Chinese stocks are the most expensive in four years as traders lose confidence in forecasts for a rally by Credit Suisse Group AG, Morgan Stanley and Deutsche Bank AG.
The price for three-month bearish put contracts to sell the Hang Seng China Enterprises Index rose to 1.41 times the cost of bullish calls on Sept. 1, the most since March 2007 and up from 1.05 in May, according to data compiled by Bloomberg. Puts that pay owners should the gauge fall 10 percent cost 1.34 times bullish contracts as of yesterday.
Investors are seeking insurance from declines after the index of Chinese companies available to foreign investors fell 12 percent last month, the most since October 2008, leaving the stocks with the lowest price-earnings ratio in almost three years. Strategists say the equities are too cheap to pass up, with Credit Suisse forecasting a 23 percent rally in the index by year-end, while Deutsche Bank and Morgan Stanley recommend investors “overweight” the shares.
“People are more bearish because they remember the dramatic moves in the market” after the collapse of Lehman Brothers Holdings Inc. in September 2008, Winner Lee, the Hong Kong-based head of Asia derivatives strategy BNP Paribas SA, said in a Sept. 5 telephone interview. BNP was ranked as the top equity derivatives firm by Euromoney magazine in 2010. “You have people who are anticipating a crisis.”
Twice as Much
The Hang Seng China Enterprises has lost 17 percent this year, almost twice as much as the MSCI All-Country World Index, amid speculation the Chinese government will maintain policies to curb inflation as global growth slows. The central bank has raised interest rates five times in the past year and boosted lenders’ reserve requirements on nine occasions. Gross domestic product growth is forecast to slow to 8.75 percent in 2012 from 9.3 percent this year, according to the median projections in a Bloomberg survey of economists.
A report tomorrow may show China’s consumer prices rose 6.2 percent in August from last year, according to the median estimate in a Bloomberg survey. A gauge of non-manufacturing industries in China dropped to 57.6 last month from 59.6 in July, the China Federation of Logistics and Purchasing reported on Sept. 3. A reading above 50 indicates expansion.
“Investors are focusing more on the bad news, on the risk, rather than the valuations, which are very cheap at the moment,” Edward Chan, who oversees about $1 billion at Royal London Asset Management in London, said in a telephone interview yesterday.
Falling Valuations
The Hang Seng China Enterprises is valued at 9 times reported profit and reached the lowest level since November 2008 last month, according to data compiled by Bloomberg. The current valuation is 26 percent below that of the MSCI All-Country World Index, which tracks shares in 45 developed and emerging markets.
The relative expense of bearish options to bullish ones, known to traders as skew, has surged across Asia. Three-month puts on South Korea’s Kospi 200 Index jumped to 1.74 times the cost of calls on Aug. 24, the highest since November 2007, according to data compiled by Bloomberg. Skew on Hong Kong’s Hang Seng Index jumped to 1.47 on Aug. 30, the most since May 2010, while it reached 1.53 for Taiwan’s Taiex Index on Aug. 31, its highest level since April.
While Deutsche Bank’s Ajay Kapur cut his weighting on China equities to a “modest overweight” last month, he’s bullish on banks and real-estate stocks. Financial companies in the MSCI China Index trade at 7.8 times reported profit, the cheapest since October 2008, according to data compiled by Bloomberg.
‘Classic Panic’
“This looks like a classic panic, not the start of a bear market,” Kapur wrote in an Aug. 29 note. “While recession risks have risen, most leading indicators we track are not signaling one yet.”
Vincent Chan at Credit Suisse predicted a rebound in Chinese shares in a Sept. 1 report, citing valuations at “distressed levels.” He cut his year-end forecast for the Hang Seng China Enterprises to 13,000 from 15,000. It closed at 10,544.86 yesterday. Morgan Stanley raised its allocation to emerging-market equities to the highest since April 2009 because of valuations and forecasts that the global economy will avert a recession, according to an Aug. 15 note.
China-linked options had signaled traders were increasingly bullish earlier this year. The cost of iShares FTSE China 25 Index puts versus calls fell close to a two-year low on July 25 on speculation higher interest rates wouldn’t slow the world’s second-largest economy. The U.S. exchange-traded fund that tracks companies such as China Mobile Ltd. and Bank of China Ltd. then slid 17 percent to the lowest level since May 2009.
Volatility Index
Hong Kong’s HSI Volatility Index fell 2.9 percent to 31.38 as of 2:14 p.m. local time, for a third day of losses. The gauge, which measures the cost of using options as insurance against declines in the Hang Seng Index, has jumped 73 percent this year. The VIX, as the Chicago Board Options Exchange Volatility Index is known, is up 88 percent in 2011, and the VStoxx Index that tracks Euro Stoxx 50 Index options has jumped 82 percent year-to-date.
“The fear is out there and in some ways it can become a self-fulfilling prophecy,” Katherine Schapiro, a San Francisco- based manager at Sentinel Asset Management Inc., which oversees about $20 billion, said in a telephone interview on Sept. 6. “The driver of growth has been China, and now the question that a lot of people have been asking is how much is China slowing down.”
--Editors: Joanna Ossinger, Nick Baker
To contact the reporters on this story: Lynn Thomasson in Hong Kong at lthomasson@bloomberg.net; Cecile Vannucci in Amsterdam at cvannucci1@bloomberg.net
To contact the editors responsible for this story: Nick Baker at nbaker7@bloomberg.net; Nick Gentle at ngentle2@bloomberg.net; Andrew Rummer at arummer@bloomberg.net
