The decline in Chinese stocks continued Wednesday, leading the Deutsche China A-Shares ETF to lose nearly 8 percent in two sessions. That may inspire some to play for a Chinese bounce. But due to an interesting market dynamic, there might be a far better way to do just that than simply buying the ETF.
As Chinese equities have fallen, and more and more investors seek to get exposure to the downside for speculation or hedging purposes, the shares have gotten increasingly difficult to short. According to the most recent data available to Susquehanna, the A-Shares ETF had a total short interest position of 7.1 million shares, with only 15.4 million outstanding. That means that finding the shares to short has become difficult and expensive.
As an alternative, traders can get downside exposure by buying puts in the options market. These derivatives, which give their owner the right to sell a given stock at a specific time and price, have consequently risen in value.
Meanwhile, the other type of options, calls, have become less expensive. That's because hedging the purchase of a bullish call option has become more costly, making traders less inclined to bet on upside.
Now, calls and puts are known as derivatives because their value is derived from the price of the stock itself. One of the ways this relationship plays out is that the price of a call minus the price of a put should be (roughly) equivalent to the current price of the stock minus the strike price of the call and put in question. In general, buying the put and selling the call is similar to buying the stock itself, given that the trader who is long both options would have upside and downside exposure.
However, since the prices of the ASHR puts have risen while the price of the calls have fallen, the theorized relationship has not held. For instance, as of midday Wednesday when the (ASHR) was trading at $39.55, the December 40-strike call could be purchased for $3.30, while the December 40-strike put could be sold for $5.10. That means that an investor can take in a credit of $1.80 for getting synthetically long the stock at $40—implying a price of $38.20. That provides a 3.2 percent discount to the share price. (Incidentally, a high dividend yield can be one reason for a disparity such as this given that call owners don't receive the dividends that share owners do, but the ASHR's 10 cent yield is negligible.)