The "trade war" has obviously been an impacting market narrative so far in 2018.
In particular, the tariff battle between the United States and China has been consistently splashed across the front page of traditional financial media sites.
A quick look at indexes and single-stocks in China provides clear evidence that this conflict has taken a real toll on the Chinese economy.
FXI, which is an ETF comprised of large-cap companies in China, is down roughly 25% from its 52-week high. The carnage elsewhere has been even more pronounced.
The Shenzhen Composite Index is down closer to 40% from its high. Shenzhen is one of the most important technology hubs in China (often referred to as China’s “Silicon Valley”), with the Shenzhen stock exchange housing many of the “growth” stocks in the Chinese economy.
Analyzing many of the best-known single-stocks in China, we find a similar theme. Alibaba (BABA), formerly managed by Jack Ma, has dropped about 30% from its 52-week high. Baidu Inc. (BIDU), the Chinese equivalent of Google, is also down over 30%. Looking at beaten-up stocks in the Chinese internet subsector, the list goes on - TECHY, WUBA, WB, YY, SOHU, CYOU - to name a few.
As most tastytraders already know, this type of price action (steep and south) is usually accompanied by a jump in implied volatility. That has surely been the case this time around as well.
An important thing to remember is that increased movement in the Chinese market can theoretically be attributed to an external event - the trade war. That in turn means that government intervention is playing a large role in the valuation of those companies, much like intervention by the US Federal Reserve during 2008-2009 had a big impact on financial companies - albeit a different one.
Because much of the implosion in China’s equities can be linked to the trade war, it becomes a little bit more difficult to rely on “mean reversion.” That’s because nobody really knows how long the trade war could last - it could end next year, or it could end tomorrow.
In this situation, it's important to recognize that while implied volatility (and IVR) may be elevated in Chinese equities, that doesn’t necessarily mean it’s a great place to deploy risk, particularly of the short premium variety.
As always, that will depend on your own strategic approach and risk profile. The relative attractiveness of these opportunities also depends on your outlook for the trade war, and the degree of confidence you have in that view.
Fortunately, if you want to learn more about the Chinese internet subsector, you can do so without risking any capital whatsoever.
A recent episode of Anatomy of a Trade outlines some trades made in BABA over the last couple months that can help you gain experience and insight into trading Chinese equities, or any other high-risk symbols/subsectors that you may be considering.
With the benefit of hindsight, you can follow the trades that were deployed, and observe how they were managed based on movement in BABA. This exercise should provide you with valuable perspective on what to do when encountering similar situations in the future - as well as what not to do.
If you have any questions about the tactics or positions described in Anatomy of a Trade, don't hesitate to leave a message in the space below, or contact us @tastytrade (Twitter) or firstname.lastname@example.org (email).
We look forward to hearing from you!
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.
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