While the U.S. major stock markets are trading at or near all-time highs, Chinese stock markets are struggling as of late. iShares FTSE/Xinhua China 25 Index (ETF) (NYSEARCA:FXI), which is comprised of the biggest China-based companies traded on the Hong Kong Exchange, is the perfect example. Since making a recent high of $39.62 on March 20, FXI stock is down 3% — despite a pop on Tuesday — while the S&P 500 is up 1.42%. I expect this trend to continue and for FXI to continue to underperform over the coming weeks.
Click to Enlarge A closer look at the components of the FXI show that one stock, Tencent Holdings Ltd (OTCMKTS:TCEHY), comprises over 10% of the index while financials weigh in at 30% and major oil at 10%.
Tencent is looking toppy on the charts after a 10% jump over the past month and oil and financials are certainly struggling lately. This combination points to further weakness in FXI stock.
From a technical perspective, FXI is at a critical juncture. $37.50 is major support on FXI, having bounced off that level three times. A meaningful break of the support level would likely lead to a meaningful leg down in Chinese stocks.
As one of the world’s major drivers of economic growth, China has a huge appetite for commodities such as iron, steel, oil, and copper. According to Market Index, “Growth in China (the world’s largest consumer of metals) has affected the price of iron ore so much recently that the spot price can almost be considered a proxy for China’s economic health.”
Yet all of these commodities have seen dramatic deterioration in prices lately which portends a dramatic slowdown in Chinese growth. The iron ore chart below shows just how dramatic the slowdown has been.
Another concern is the validity of the data reported out of China. The Financial Times report shows just how pervasive the overstatement can be. Given this morning’s extremely weak Chinese import data of 11.9% growth (versus expectations of 18%) and much less than 20.3% growth in March, it is easy to see a big-time breakdown in Chinese stocks.
To position for a mini meltdown, a simple long put play makes intuitive sense.
FXI ETF Trade Idea
If you believe in continued weakness from Chinese stocks, buy the FXI July $38 puts at $1.10 or better.
Be aware that these puts are currently just out of the money because of Tuesday’s surge, with FXI last quoted at $38.35. Maximum risk is the premium paid of $110 per option.
As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities. Anyone interested in finding out more about option-based strategies or for a free trial of the Delta Desk Research Report can email Tim at tbiggam@deltaderivatives.com.
