Chart of the Day – FXI: Yuan a fight?

by riskreversal December 16, 2016 4:14 pm • Chart of the Day

Remember when Chinese equities (Shanghai Composite) inflated 180% from their June 2013 lows to their June 2015 highs:

Shanghai Comp 2013 – 2015 from Bloomberg

Then the index got cut in half. It put in lows earlier this year, before regaining some ground. But it remains down 12% on the year:

Shanghai Composite June 2015 to Present from Bloomberg

The popping of the 2015 stock bubble, and the subsequent devaluation of their currency in August of 2015 had major reverberations in our markets that lasted for months and resulted in two 10% declines in the S&P 500. And then to start 2016, fears of slowing global growth, particularly China, and the popping of a credit bubble caused mayhem in our markets in Jan and Feb.  Translation, any pick up in volatility in Chinese stocks is worth keeping an eye on.

FXI, the iShares China Large Cap etf that tracks the performance of Chinese stocks listed in Hong Kong is down about 5% on the week as rhetoric, and the potential for a trade war heats up (earlier in the week Chinese trade officials threatened slapping fines on an un-named US automaker).  As a result, the FXI broke the uptrend that had been in place from its 52 week lows, and 3 month support at $36:

FXI 1yr chart from Bloomberg

The President-elect stated routinely on the campaign trail that China is a Currency Manipulator (to make their exports more attractive) an that he might take action against them. If China is manipulating, it’s the other way these days. Despite the fact their the yuan continues to go lower, the PBOC has intervened on numerous occasions to stabilize and avoid capital flight in an attempt to stabilize the yuan, with no shortage of regulations.

And China is no longer the largest holder of U.S. Treasuries in an effort to support the Yuan by dipping into foreign exchange reserves.

And it’s not just about trade and currency. In the last week, there has been some military warning shots fired after the President-Elect put into question the long standing diplomatic agreement of the One China policy as it relates to their relationship with Taiwan:

China flies nuclear bomber over South China Sea as a ‘message’ to Donald Trump

China seizes US Navy underwater drone in international waters of South China Sea

This is probably a sign of things to come. Hopefully with continued tape bombs, not real bombs.

So what’s the trade?

I suspect FXI is a tough press here, and I’d like to see it on a bounce for a better short entry, but I suspect the President-Elect will not back down and we could see continuation of a this week’s pitching match.  Early next week I might consider the following trade targeting a breakdown back to Jan/Feb stabilization levels just above $30:

Trade: FXI ($35.50) Buy Feb 35 / 31 put spread for $1
  • Buy 1 Feb 35 put for 1.25
  • Sell 1 Feb 31 put at 25 cents

Break-Even on Feb Expiration:

Profits: between 34 and 31 of up to 3, max gain of 3 at 31 down 12%

Losses: up to 1 between 34 and 35 with max loss of 1 above 35

Rationale – This trade looks for further weakness in China at any hint of trade war rhetoric as we go into and out of the inauguration. It’s a bit of a press here so putting on this trade or similar on a bounce is probably the best bet.