10.14.2011

CHIX: Trading Chinese Volatility

10.14.2011
Terry Flanagan

The world’s second largest economy springs mixed feelings from investors, but undoubtedly spurs volatility.

Although still growing around nine percent, concerns over China’s macroeconomic troubles have spread throughout investors—sparking unpredictability within the nation’s stock market.

“We’ve taken advantage of the fact that Chinese stocks are very volatile,” said Burton Malkiel, co-founder and chief investment officer of Baochuan Capital Management (BaoCap). Malkiel is also author of the famed, A Random Walk Down Wall Street.

“We calculate something we call the CHIX—which is the implicit volatility of the Chinese stock market; much like the VIX (volatility index) is for the S&P 500,” Malkiel noted. “Chinese volatility means there are very big option premiums. We buy an index fund of stocks, and write options against that, using a one month at-the-money option.”

Malkiel’s hedged strategy, known to his firm, as the Green Dragon Fund, is commonly known as a buy-write option strategy, is also a common among U.S. trade, in times with volatility forecasts uncertain market swings. Moreover, the strategy is low cost, with a low expense ratio, according to Malkiel.

Low-cost, as is the case for many managers, is of paramount importance to Malkiel. The manager/academic also sports a reputation for supporting pure indexing strategies, due to their low fees in comparison to strategies executed by active managers.

“It may not surprise you that a good strategy for China is to buy a broad based scaled index at low fees,” he said. “Two thirds of active managers are beaten by low cost index fund, and this is very true in emerging markets and in China.”

U.S.-domiciled Chinese index funds are appropriate for most investors, but a separate account platform is often utilized for Baocap’s institutional clients.

Despite, recent concerns over a Chinese economic “hard landing,” or slowing of the country’s growth, Malkiel is still bullish about China’s fundamentals, such as double digit price earnings multiples, innovation regarding niche sectors such as solar polar, and changing intellectual property laws.

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