Trading Nation

The big bet on a big move for Chinese stocks

Trading Nation: Trading MSCI's China decision
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Trading Nation: Trading MSCI's China decision

One trader appears to be staking the better part of $2 million on a big move for the iShares China Large-Cap ETF (FXI).

On Wednesday, one of the biggest ETF options trades of the day was the apparent simultaneous purchase of 40-strike FXI puts expiring in July and 40-strike FXI calls also expiring in July.

Given that a call purchase is a bullish trade, and a put purchase is a bearish one, buying both may sound a bit odd. But the simultaneous purchase of both types of options with the same expiration and striking price is actually a relatively common options trade known as a "straddle."

In this trade structure, the purchaser of the options stands to make money so long as the underlying asset sees a big move — either to the upside or to the downside.

In this case, the trader appeared to buy 12,000 July 40-strike puts for 90 cents per share, and to simultaneously buy 12,000 July 40-strike calls for 45 cents per share. If held to expiration, the per-share value of the options trade will simply be the distance between the FXI's closing price on July 21 expiration and $40.

Since a total of $1.35 per share was paid (or $1.62 million total, since each contract controls 100 shares), the FXI has to close either below $38.65 or above $41.35 on July 21 expiration in order for the trade to show a profit. In the unlikely case that the FXI closes at exactly $40, the entire premium paid will be lost.

The trader may be trying to take advantage of the drop in options prices on the FXI. A year ago, a common measure of expected future moves for the FXI as determined by options prices ("implied volatility") was at double what the same measure is at now. This trade may betray an expectation that Chinese volatility is set to rise once again.

Of course, it is unclear what other positions the firm that put on the trade may have outstanding. This could well be one part of a multifaceted trade that expresses a more nuanced view on the ETF.

The FXI tracks large Chinese stocks that trade on the Hong Kong stock exchange, and its biggest components are Tencent and China Construction Bank.

Interestingly, Tuesday brought big news for Chinese stocks, when MSCI announced that it was adding a very small amount of mainland Chinese stock exposure to its emerging markets index. Hong Kong-listed stocks like those in the FXI are already a large component of MSCI's emerging markets index, and of products like the iShares Emerging Markets ETF (EEM) that track it.