Be Greedy When Others Are Fearful? Options Traders Bet on Chinese Stocks Recovery

International investors have avoided Chinese equities as its annual returns haven't outperformed emerging markets since 2020. Options traders are now placing their bets, seeking strategic opportunities for potential gains should the markets recover.

According to Bloomberg, there has been a surge in the volume of options that target US-listed exchange-traded funds that monitor Chinese markets amidst the volatility caused by remaining pandemic-impact, macro headwinds, and real estate market turbulence.

This investment approach is akin to purchasing inexpensive 'lottery tickets' that could yield substantial returns if the market shifts favorably.

"It's simply buying cheap lottery tickets with a potentially big payout," said Charlie McElligott, managing director at Nomura Securities International. The worse Chinese stocks fare, "the more attractive it becomes from a risk-reward perspective," he said.

The interest in ETF-related derivatives is seen as a sign that some investors are starting to respond to the Chinese government's attempts to halt the market decline.

The one-month put-versus-call skewness of the ETF, which tracks the FTSE China 50 Index, has been inverted multiple times in recent weeks and is now dropping to the most negative level that has not been seen in a year.

The implied volatility skew shows the market's bias for pricing in volatility risk to the option premium of downside puts and upside calls. If the implied volatility for downside puts is increasing relative to upside calls, then that suggests the market is pricing in a larger fear of a downside move.

According to Ling Zhou, TD Cowen's head of equities derivatives strategy, this suggests that traders have been using options to profit from market upswings.

Investor interest has been particularly pointed towards short-term derivative contracts to take advantage of Chinese equities' low valuations before critical events take place, like the National People's Congress meeting and the US presidential election.