Last week witnessed a dramatic pivot in sentiment regarding China's stock markets, revealing a landscape of evolving investor attitudes and reactionsFor years, major international financial entities, including Wall Street investment banks and hedge funds, exercised caution towards the Chinese marketHowever, there has been a notable shift toward optimism, especially concerning stocks listed in Hong Kong and the mainland A-share marketThe phrase "Go long on China" resonated throughout Wall Street, a stark contrast to the prior skepticism that frequently colored discussions about Chinese equities.

This renewed enthusiasm from market participants—particularly foreign institutions—has evidenced itself in the options marketTraders have aggressively purchased call options, aiming to capitalize on this uptrend in stock prices

The consequent increase in activity has propelled the Hang Seng Volatility Index (HSI), which reflects the general cost of options in the Hong Kong stock market, to a two-year highAs of September 30, the HSI closed at 32.56, peaking at 34.87 during trading, marking the highest levels since December 2022.

The HSI’s rise demonstrates a marked increase in options pricing, indicating that both call and put options are rapidly becoming more expensiveThis shift highlights a surge in interest from investors seeking to use options as short-term instruments for riding upward price momentumConcurrently, this scenario suggests that previously bearish positions taken by institutions employing market-neutral strategies are rapidly becoming unmanageable, as many investors flocked to the call options market in pursuit of speculative profits.

1. Policy Shift Surpasses Expectations

The collective excitement among institutional investors can largely be attributed to a sudden and unexpected shift in economic policy by the Chinese government

Following the central bank's decision to cut the reserve requirement ratio on September 24, a cascade of stimulatory measures rolled out within days, covering a wide array of sectors from consumer spending to the real estate and equity markets.

On the monetary front, the central bank's strategies included a 20 basis point rate cut, a reduction in the seven-day reverse repurchase operation rate by the same magnitude, and a reserve requirement cut of 50 basis points, releasing over a trillion yuan into the economyIn light of the liquidity circumstances, additional cuts of 25 to 50 basis points could be on the horizon.

Addressing the real estate sector, the down payment ratio has been reduced to 15% across the board for both first and second home purchasesThis uniformity aims to ease the threshold for mortgage loans, further decreasing existing mortgage rates by an average of 50 basis points—an initiative projected to relieve interest burdens for roughly 50 million families.

A critical element of this policy communication was a distinctly clearer commitment to stabilizing property prices, with explicit targets set to “promote the stabilization of the real estate market." This marks a significant departure from previous conjectures regarding government support, intensifying expectations for action on both the demand and supply sides.

In the context of the stock market, the establishment of two new structural monetary policy tools by the central bank serves as a stabilizing force for equity prices: the securities fund and insurance company swap convenience tool, alongside a specialized loan facility aimed at bolstering stock repurchases

Experts estimate these measures could inject an additional 800 billion to 2.4 trillion yuan into the marketplace.

On a similar note, the recently concluded weekend saw China's major metropolitan hubs—Shanghai, Shenzhen, and Guangzhou—all implement new housing policy initiatives, easing purchase restraintsNotably, Shanghai's “Seven New Policies” initiative includes lowered down payments and loosened regulations for out-of-town buyers, while Guangzhou eliminated all such restrictionsShenzhen’s adjustments reduced minimum down payment thresholds for first and second homes, thus mimicking a trend of facilitation across key regions.

The synchronization of these developments has created a boost in market sentimentFor instance, on the very day of the new regulations, the Hang Seng Index surged past the 21,000 mark, reaching an intraday high of 21,488—its highest since February 2023. Correspondingly, the Hang Seng Tech Index jumped 6.7%, reaching heights close to 5,000 points.

Meanwhile, on the mainland, the Shanghai Composite Index ascended by 8.06%, breaking through the 3,300 barrier, while the Shenzhen Component Index escalated by 10.67%. Impressively, the ChiNext rose 15.36%, indicating a sweeping recovery of losses incurred in the previous months.

In the words of Michael Oh, a portfolio manager at Matthews Asia based in San Francisco: “It seems that this time the government felt a sense of urgency

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If investors believe that the Chinese government will continue to support the market robustly, the rebound could persist, as valuations in the Chinese market are indeed too cheap.”

2. Institutional Investors Flood into the Options Market

With the sharp uptick in the Chinese stock market—including both Hong Kong and A-shares—the cost of hedging against declines in the "China Enterprises Benchmark Index" has plummeted to its lowest levels since 2015. This scenario indicates that the expense associated with put options has reached historic lows, signaling a scarcity of investors utilizing these options to safeguard against falling markets.

It is crucial to highlight that this decline in hedging costs aligns with prior occurrences, notably during the exuberant bull market of 2015. During times of significant market corrections—such as the pandemic in 2020 and the drastic downturn of Hong Kong equities in 2022—hedging costs escalated dramatically

The current cost decline mirrors the levels last seen in 2015, reflecting widespread market sentiment that the risk of declines appears minimal, obviating the need for put options as protection.

Simultaneously, the ratio of call options to put options has surged to its highest level since June, demonstrating the intensity of bullish sentiment, often bordering on euphoriaAn increasing number of foreign investment institutions centered around the Chinese market are opting for call options as a method of leveraging gains, with negligible hedging against potential downturns.

Among prominent figures, notable investors like billionaire David Tepper are fervently acquiring Chinese stock assets, with the trading volume of call options linked to exchange-traded funds (ETFs) tracking various baseline indices rising precipitously

In the U.Smarket, a marked bullish trend has emerged in the trading of American Depository Receipts linked to Chinese companies.

Moreover, many investors are manipulating call spreads by rolling over impending expiring options into further-out expiration dates, extending their positions rather than liquidating themThis approach permits them to control costs or secure profits while remaining exposed to potential exploits.

Call spread strategies—where investors buy and sell call options with varying strike prices—allow participants to confine potential lossesThe sale of options partly offsets the costs of those acquired, while simultaneously capping maximum profit potential.


Mark Franklin, a senior portfolio manager at Manulife Investment Management, acknowledges the persistent long-term concerns but emphasizes the prevailing optimism among investors

Citing the low allocation of global capital to the Chinese market, he forecasts a significant brief rebound in Hong Kong and A-shares potentially ignited by aggressive short squeezes.

Amid the fervent optimism, some voices of caution emergeChris Murphy, co-head of derivatives strategy at Susquehanna International Group, cautions that the surge in volatility associated with bullish options may rapidly reverse if onwards momentum dwindles.

Murphy stresses prudence for investors looking to employ put options as a counter-action, noting that falling prices coupled with declining implied volatility could severely constrain the benefit derived from such positionsHe advocates for strategies including put spreads or protective collars, or reducing risk exposure through varied options techniques.

3. What Lies Ahead?

By the close on September 30, the RSI (Relative Strength Index) of the Hang Seng Index had reached 96.5, marking the highest level since 2018, while the Shanghai Composite's RSI came in at 94.1. For the RSI, a reading above 70% indicates market strength; above 80% represents signs of being "overbought,” and readings exceeding 90% denote a state of extreme overbuying.

The ongoing "overbought" conditions suggest a buildup of profitable positions, translating into potential profit-taking—regardless of investors’ underlying optimism—triggering market hesitation or short-term pullbacks as technical indicators stabilize before the next series of movements.

Diverging from past trends, recent market data suggests a rise in short-selling proportions alongside the market rally, revealing a level of skepticism surrounding future price movements

Consequently, investors now ask how much upside potential remains after a week of rallies and heading into the last trading day prior to the holiday.

Regarding future projections, China International Capital Corporation posits that in the short term, state-owned enterprises and previously undervalued sectors are often appealing in rebound strategiesConversely, a medium to long-term perspective necessitates monitoring the fulfillment of policy expectations—whether they surpass, meet, or underperform prior assessments.

In the short run, the central bank's financial innovations may significantly benefit distressed enterprises, especially state-owned onesOn the other hand, persistently lagging sectors such as internet software and food retail, which have been disproportionately underperforming, may experience sentiment-driven rebounds.

In the medium term, if the government adheres to policies that yield positive outcomes, cyclical sectors may outperform—including consumer products, the real estate chain, and non-banking financial institutions

Additionally, growth stocks sensitive to interest rate shifts should not be overlooked, encompassing sectors like technology, internet, and biotech that could benefit from improving market conditions.

Yet, if fiscal policy lacks timeliness or vigor, market digestion may necessitate rotations of profit-takingIn that event, maintaining a focus on high-dividend plays could prove advantageous, while specific policy-support sectors could experience significant elasticities, especially those paired with industry vitality.

Overall, entering October, the U.Smarket is likely to exhibit increased volatility while pullbacks seem inevitableIn juxtaposition, Chinese assets on the Hong Kong and A-Share markets present themselves at historically lower price points, underpinned by unprecedented government support commitments, suggesting that value in these sectors, particularly when compared to their U.S