China's Asset Surge! How to Bet on the Downside with Options?

Over the past week, traders have accumulated large amounts of call options on leveraged ETFs tracking Chinese indices. Following China's signals of increased economic support next year, stock prices soared, yielding unrealized gains of over $130 million.

Option Buying Spree on Leveraged ETFs

The focus has been on two ETFs: Direxion Daily CSI 300 China A Bull 2x Shares (CHAU) and Direxion Daily FTSE China Bull 3x Shares (YINN). These ETFs, with a combined market cap of around $2.5 billion, trail larger funds like iShares China Large-Cap ETF (FXI), which boasts an $8 billion market cap.

From November 29 to last Friday, traders purchased nearly 180,000 call options on YINN with a strike price of $27 expiring in January 2026, at an average cost of $9.35 per share. On December 2, traders bought approximately 210,000 call options on CHAU with a May 2025 strike price of $15, averaging $2.64 per share, investing over $55 million.

By early Monday, the price of these contracts surged to $15.40 and $4.02, respectively, netting traders a combined $138 million in unrealized gains according to Bloomberg calculations.

Open Interest and Market Sentiment

These trades appear to be speculative positions rather than part of spreads or hedged with stock. The open interest for both contracts has remained stable or increased since their purchase, indicating positions are being held.

China's stock market surged after the Politburo pledged "moderately loose" monetary policy for 2025, followed by a rally in U.S.-listed ADRs and ETFs. On Monday, CHAU rose 15%, while YINN jumped 27%.

Evercore ISI strategist Neo Wang noted that China's "unprecedented forward-looking guidance for 2025 economic support" reignited interest in Chinese assets. He anticipates the National People’s Congress in early March will announce strong fiscal measures, potentially including higher deficit ratios, expanded local government bonds, and over $1 trillion in ultra-long-term sovereign bonds.

Unusual Activity in Small ETFs

The trade sizes and maturities stand out for these smaller ETFs. Prior to December 2, CHAU's 20-day average option volume was just 6,150 contracts, while YINN’s was around 34,000. Although speculative bets typically involve shorter-dated options, the purchase of longer-dated options suggests traders are betting on sustained stimulus through 2025.

Chris Murphy, co-head of derivatives strategy at Susquehanna International Group, noted:
"Leveraged ETFs amplify risk and reward, offering larger returns."

He added:
"What’s surprising is the limited profit-taking on Monday after the major moves, suggesting investors expect further positive announcements from China."

Shorting Amid Volatility

For those anticipating market reversals or volatility, a bear call spread strategy could be used to short YINN.

What is a Bear Call Spread?

A bear call spread is an options strategy for traders who expect a decrease in the price of an underlying asset. This strategy combines selling a call option at a lower strike price while buying a call option at a higher strike price, limiting potential risk.

Example: Shorting YINN with a Bear Call Spread

Setup:

• Current Price of YINN: $36

• Trader’s Expectation: YINN will drop to around $25 by January 3.

Step 1: Sell a $25 call expiring January 3

• Premium received: $1,230

• Contract size: 100 shares

Step 2: Buy a $36 call expiring January 3

• Premium paid: $400

• Contract size: 100 shares

Strategy Overview

1. Sell a $25 call

   • Premium income: $1,230

   • Contract size: 100 shares

2. Buy a $36 call

   • Premium cost: $400

   • Contract size: 100 shares

3. Net premium income

   • $1,230 (received) - $400 (paid) = $830 initial net credit

Key Price Levels

1. Maximum Profit: When YINN ≤ $25

   • Both calls expire worthless.

   • Net profit: $830 (initial premium income).

2. Maximum Loss: When YINN ≥ $36

   • Loss = Difference in strikes - Net premium income: (36−25)×100−830=270 USD(36 - 25) \times 100 - 830 = \mathbf{270 \, \text{USD}}(36−25)×100−830=270USD

3. Breakeven Price:

   25+8.30=33.30 USD25 + 8.30 = \mathbf{33.30 \, \text{USD}}25+8.30=33.30USD

   Loss starts beyond this price.

Bear Call Spread: A Balanced Risk-Reward Strategy

This setup allows traders to profit from modest declines or limited upward movement in YINN while capping potential losses at a manageable level.