How to Play China With Options

It would cost you a pretty penny to short ASHR outright

Jul 29, 2015 at 9:08 AM
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Want to go short China? It's going to cost you a bit. This, from Bloomberg:

"At the current cost to borrow shares of the biggest U.S. exchange-traded fund investing in mainland stocks, short sellers need the equivalent of a 40 percent annualized drop just to break even, according to Markit, a London-based research firm. The 28 percent plunge in the Shanghai Composite Index from its bull market high and volatility at the highest level in 18 years have made it more expensive than ever to profit from declines in the Deutsche X-trackers Harvest CSI 300 China A-Shares ETF as investors push bets against the fund to near a record."

Not to mention that it's not exactly the tightest market I've ever seen. But let's take a look. 

As I type, the Deutsche X-Trackers Harvest CSI 300 China A-Shares ETF (ASHR) is trading at $39.45. The September 40 calls are the tightest nearby quote, so we'll use that line to price the reverse/conversion market. They're $1.90 bid, $2.10 ask, while the puts are $4.10-$4.60. 

Add them up, and you can synthetically buy ASHR at $38 if you buy the calls at $2.10 and sell the puts at $4.10. If you could short the ETF itself at $39.45, you could lock in $1.45! But alas, you can't actually short it there… or, rather, you can, but you'll have to pay some hefty borrowing costs. 

If you assume you break even on this -- not an accurate assumption, but bear with me for a sec -- then that implies it will cost you $1.45 to borrow ASHR between now and September expiration.

That's 3.67%. Not so terrible, right? 

Well, it's only 52 days, so we have to annualize it. And when we do that, it comes out to 25.7% 

But unfortunately, that assumes you break even. You don't, necessarily. For one thing, the borrowing costs are not constant; this just estimates the ultimate number. It could go much higher. What's more, you run the risk of getting bought in on your actual stock short, and that has somewhat open-ended risk attached to it. 

There's an alternative, though. We can create a synthetic short via options. To that, we buy the puts at $4.60 and sell the calls at $1.90, effectively shorting the shares at $37.30. That's 5.45% below ASHR now, an annualized drop of 38.25%. That's presumably where that Bloomberg number comes from. 

So, even if we use the midpoint of the two, yeah, it's pricey to short here and essentially assumes a big drop. And it's likely you can't always borrow shares.

On the other hand, if you want to buy the shares, might as well use the options board! You don't earn the "income" of loaning out your shares, but your broker/clearing firm is likely pocketing them anyway. 

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.


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