A Charged-Up China Trade

Hey Traders,

If you read my email about all the different VIXs out there … you know that there’s some pretty specific volatility measures out there

These can be a huge tool to use to your advantage if you’re looking to make trade options in a specific sector, or even if you’re thinking about buying certain stocks.

Or, in some cases, it can give you some interesting insight into geopolitical developments …

For example, one volatility measure we’ve been keeping a close eye on over here is the Cboe China ETF Volatility Index (Ticker: VXFXI), which measures the implied volatility (IV) of the iShares China Large-Cap ETF (Ticker: FXI).

VXFXI one-year chart courtesy LiveVol

And in case you haven’t been watching, there’s some interesting developments shaking Chinese companies listed on U.S. Exchanges, resulting in a small-but-present vol spike on the VXFXI yesterday.

The Chinese government has been cracking down on large tech companies, including ride-hailing stock DIDI Global (Ticker: DIDI), citing data and cyber security concerns.

DIDI – which only started trading on the New York Stock Exchange (NYSE) a week ago – is one of several tech companies being investigated.

Unfortunately, the “data concerns” concern isn’t only being felt by DIDI and the other names under scrutiny, as investors fear the potential for more widespread government crackdowns.

Pretty much all U.S.-traded Chinese stocks were feeling the crunch yesterday …

Including Chinese electric vehicle maker Li Auto (Ticker: LI).

LI has actually been fighting recent headwinds, in spite of reporting better-than-expected monthly deliveries for June, and exceeding Q2 delivery estimates by over 2,000 vehicles.

Headed into the report, LI was trucking higher with solid buying volume, but heavy selling activity late last week smothered any post-event upside.

However, for the most part, LI has been enjoying a steady climb higher over the last two months, in spite of some early-year turbulence:

Chart courtesy StockCharts

And it seems one trader in particular is betting that the recent sell-off will be both contained and short-lived …

Put Spread, But Make It Bullish

On Tuesday, this trader took advantage of some of the Chinese crackdown chaos to purchase a bullish put spread.

They purchased 6,000 July 29-strike puts for $0.22 each, or a total outlay of $132,000. This strike represents a 14.6% decline from Tuesday’s close of $33.58, and as of Tuesday evening, has only about a 13% probability of ending up in the money.

At the same time, this trader actually sold 6,000 July 31-strike puts for $0.46 – bringing in a total premium of $276,000. This strike is only 8% below LI’s closing price, and has a 26% probability of ending up in the money.

So what does this tell us?

This tells us that there’s someone laying down a pretty decent chunk of change betting that – at worst – there will be limited downside potential for LI, but they’re really banking on LI maintaining above $31.

If LI manages to do this, and both sets of put contracts finish out of the money, this trader will walk away with a $144,000 profit (the $276,000 premium, less the $132,000 outlay on the lower-strike puts).

However, while that’s certainly not a payday to sniff at, there is quite a bit of risk this trader is taking on.

While their maximum profit is $144,000, their maximum loss is a whopping $1,056,000 ($31 strike – $29 strike – ($0.46 – $0.22) x 100 x 6,000).

That’s quite a gamble!

But considering LI hasn’t fallen below the $31 mark since late June, and the stock even managed to recover from Tuesday’s broader headwinds faced by Chinese stocks, it seems reasonable to think the shares might be able to hold their own until July expiry, which is only 10 days away.

It’s also worth noting that in spite of the investor skepticism about potential Chinese tech stock crackdowns, LI’s 30-day at-the-money implied volatility (ATM IV) is in just the 10th percentile of its “annual” range, implying LI’s options are relatively cheap right now (note that LI made its IPO on July 30, 2020, so it’s annual range is a bit shy of a full 52 weeks).

It seems like there’s someone pretty confident LI will manage to hold its own over the next week and a half. Barring more investor-confidence-shaking news out of China, it would seem as though the odds are in their favor, but only time will tell. 

Your Only Option,

Mark Sebastian

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