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Sector-Balanced Futures – One Way to Manage Chinese Equity Exposure
After the Chinese government announced new stimulus measures on Sept. 24, the MSCI China A Index surged 32% to Oct. 8, before retreating nearly 9% through Oct. 18, as investors’ views on the effectiveness of the measures has whipsawed.1 Chinese equity options have followed suit with the move to an inverted volatility term structure alongside a sharp rise in implied volatility.2
In the first week of October, implied volatility spiked to 56%, significantly above the five-year average of 28%. Emerging markets (EM) experienced a similar surge, pushing their implied volatility to 24%, largely driven by the Chinese market. Investors are watching this jittery behavior and starting to reassess opportunities and risks in China’s equity markets.
A break with the past: rising futures volumes in a rising market
One tool international investors could consider to gain or manage exposure to the A-shares market are futures linked to the MSCI China A 50 Connect Index, which has maintained a 0.96 correlation with the broader MSCI China A Index over the last five years.3 Composed of 50 large and liquid stocks, the MSCI China A 50 Connect Index is a sector-balanced representation of the market.
Daily trading volumes for these futures have surged from Sept. 24 to Oct. 18, 2024, with year-over-year growth surpassing 170%, pushing the year-to-date growth rate in volume to 45%. Previous volume spikes coincided with declining equity markets, such as from August 2023 to January 2024 when the A-share market declined amid high outflows from international investors. The rise over the last several weeks has coincided with rising markets, however, suggesting some investors are taking tactical positions in line with expectations of a bullish scenario linked to the policy interventions.
Term structure has inverted, and volatility risen sharply, in Chinese and EM equities
Steep uptick in MSCI China A 50 Connect Index futures volume post stimulus
1 Returns are reported in gross USD.
2 Implied volatility is based on the average implied volatility of 30-day at-the-money (ATM) call and put options. Term structure is calculated using the 91-day to 365-day implied-volatility ratio of ATM options. Options linked to the MSCI Emerging Markets Index and iShares MSCI China ETF were used to calculate the metrics shown for EM and China volatility, respectively.
3 Correlation calculated based on monthly returns over the last five years through Q3 2024.
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