Wednesday’s news from China can be summarized as a slowing trend in retail spending, investment, manufacturing and lending and a growing trend of inflation.
That is problematic for the Chinese who are facing unprecedented pressures internally and externally to manage their currency, balance their massive trade deficit and prevent inflation from leading to a banking collapse and popular unrest. And we thought we had problems in the U.S.
It was hoped that demand from the Chinese economy would help support commodity prices, U.S. Treasury/dollar prices and global growth during the next phase of economic recovery so traders are very sensitive to any negative changes in the economic environment in Asia.
The economy could begin to spiral down and an emerging economic slowdown in North America and Europe could contribute to this trend. However, I always say that “where there is disruption there is opportunity.”
Here are three ideas to profit from problems in China.
#1 – Long-Term Puts on Chinese Stock ETFs
Chinese stocks can become very volatile at times but have been stuck within a consolidation range following the 2009 rally. Traders could buy puts on an ETF like the iShares FXI (NYSE: FXI) on a breakout to the downside. Long term puts provide more flexibility and suffer less from time-value erosion on a day to day basis but a synthetic short (long put plus a short call) could be preferable to a risk tolerant options trader.
#2 – Bearish Chinese ETFs
These days there is an ETF for just about any strategy — including a short bet against Chinese stocks. The ProShares UltraShort China ETF (NYSE: FXP) was up +6% at one point on Wednesday as traders dealt with this round of bad news. If Chinese stocks continue to decline, this ETF is designed to double the inverse of those losses. That means that if Chinese stocks drop -5% on a given day FXP will be up +10%.
Leverage and inverse ETFs come with special challenges and are really meant to be used for short term trades but when used appropriately they can be very effective and cost efficient.
Short Overbought Chinese Stocks
There are several Chinese stocks listed for trading on U.S. exchanges. Baidu.com (NASDAQ: BIDU) is a good example of such a company. Individual stocks often have a higher beta (more volatile) than market indexes and for a VERY risk tolerant trader they may present some interesting opportunities. For example, BIDU was down 4% on Wednesday on the news and after some extreme gains over the last few weeks it could be due for a larger correction. This is definitely a contrarian investment and is therefore very high risk.
It is too early to call this a “crash” but the symptoms Japan and the U.S. experienced before our respective credit crises over the last 20 years are all definitely present in China now, which means that we would expect to see very high volatility in the near term. With proper money management this could present some interesting opportunities to profit.
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