Buy-On-The-Dip Opportunity in China ETFs

Includes: FXI, PGJ
by: Larry MacDonald

We’re in. Wednesday's sell-off in Chinese stocks, caused by an increase in the stamp-duty tax, afforded a “buy-on-the-dip” opportunity to initiate the Jesse Livermore strategy contemplated in our May 29 blog post.

The instruments are the call options on the iShares FTSE/Xinhua China 25 Index (NYSEARCA:FXI) and PowerShares Golden Dragon Halter USX China (NASDAQ:PGJ). The swing in prices over the day was more than enough to cover bid-ask spreads and leave Jesse L. with some profits.

Specifically, at 10:30 a.m., FXI July call options (strike price of 108) traded at an ask price of $5.90 and finished the day at a bid of $6.80 -- for a gain of 15%. PGJ July call options (strike price of 22) had an ask price of $1.65 mid-morning, and finished at a bid of $1.70, up 3%. Let’s see where this mad-money wager goes.

The tax increase doesn’t really address the root causes of the mania, such as the 10% annual growth in the economy and company earnings. It just ratchets down the market to a lower level from where it will likely restart its upward trajectory.

The authorities will likely introduce additional measures to rein in the bubble, so Jesse L. will not be staying long in his trade (indeed, he may switch sides). As the Financial Times of London reports:

“The likely measures include making it easier for Chinese investors and institutions to invest overseas, an increase in domestic initial public offerings and other share sales and the launch of an equity index futures contract. Some analysts also expect further increases in interest rates …. If the market still continues to rally, the authorities might consider imposing a capital gains tax on share trading ….”

PGJ, FXI 1-yr. chart:

PGJ FXI Investment

Related Articles: David Fry's Market Outlook for Wednesday; Morgan Stanley China Closed End Fund: NAV Up While Market Price Lags; 'Pao Mo': That's Chinese for Bubble; The Bubble Theorists Have Shanghai Wrong; Is the Chinese Market Heading Towards a Bubble or Solid Fast Expansion?

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