Trading Nation

How US investors can play China now

Tale of two Chinas
Tale of two Chinas
Big trouble in China?
Big trouble in China?
Robert Shiller on stocks vs. bonds
Robert Shiller on stocks vs. bonds

The wild ride for Chinese stocks continues, with the Shanghai Composite now down some 25 percent in the last month, though the index has still risen more than 80 percent over the past year.

The Chinese government, which cheered the rally on the way up, is now attempting to stem the decline. New initial public offerings have been suspended, and Chinese brokerages have pledged to buy about $19 billion worth of stocks.

For Neil Azous of Rareview Macro, the Chinese government is attempting to "take over the stock market," with the use of powerful mechanisms he equates to Zeus' call to "release the Kraken."

"We walk into this week looking to get more long China's stock and are even considering how to add a long bond market position," Azous wrote. "This form of 'risk parity' in China strikes us as very appealing, given that the Kraken has been released."

However, many investors have argued that Chinese market valuations are simply too high, and the new measures will not succeed in ending the correction.

Whichever way U.S. investors see China going now, a variety of potential trades suggest themselves.

Stacey Gilbert, head of derivative strategy with Susquehanna, recommends that China bulls buy a call spread on the FXI ETF, which is a defined-risk way to bet on upside.

Boris Schlossberg, a currency trader with BK Asset Management, is bearish on China, arguing that "you can throw everything but the kitchen sink at the Chinese economy right now," and slowing growth will still mean losses ahead.

To play for a further Chinese decline, Schlossberg recommends shorting the Australian dollar, given that "the fortunes of China reflect themselves on the fortunes of Australia."

Further, "if the Chinese market really blows off and has a huge bubble top, you're going to see massive ramifications all across Asia," Schlossberg said Thursday on CNBC's "Power Lunch."

But the impact on American equities may remain muted.

"China goes down, and the rest of the world seems to shrug it off," Block told CNBC on Thursday. There doesn't seem to be any correlation between China's selloff and the movement in U.S. stocks, he added. And according to Block, U.S. institutional investors were not largely involved in the selling, "so I don't see the contagion problem."

Cowen & Co.'s head of sales and trading, David Seaburg, said China's volatility might not last long, as Beijing could take more measures to end the whipsaw action. "You're not going to see this market pull back in a meaningful way," he told CNBC. "I think the government is basically going to protect it at all costs."

Seaburg said that for all practical purposes, Beijing's actions are really no different than "what the ECB and the Fed did to inflate asset prices here in the U.S. and abroad." By that logic, he said, China's markets are "probably going to go higher."

But the artificial nature of government-inflated stock prices did give Seaburg pause. "I'm uncomfortable with it, there's no question," he said. "It's not the type of market I'd want to invest in, but I do believe that it will gravitate higher."

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