EVEN with a recent sharp decline in China’s equity market, some do not believe the selling is at an end, judging by activity in the options market.

    In early August, the People’s Bank of China surprised the world by devaluing the yuan by nearly 2 percent on the heels of a run of poor economic data, and Chinese stocks sold off sharply.

    Shares of the China Large-Cap Exchange Traded Fund, which gives U.S.-based investors exposure to 50 of the largest Chinese stocks traded on the Hong Kong Stock Exchange, have dropped 17 percent since then.

    However, there has been no let-up in bearish sentiment. Options traders have been loading up on put options that would offer protection against further declines in shares of exchange-traded fund (ETF).

    Put options on the funds’ shares outnumber call options by the biggest margin since April. Currently there are 1.3 puts open for each open call contract.

    “Even though the FXI is down, the Shanghai Composite Index has a lot of room to correct further,” said Mike O’Rourke, chief market strategist at Jones Trading.

    Despite a 29 percent drop over the last three months the index is still up by 29 percent for the last 52 weeks.

    The 30-day skew, the difference in volatility between a 10 percent out-of-the-money put and a 10 percent out-of-the-money call, is in the 95th percentile of its 52-week range, according to Trade Alert. The high skew points to the relatively strong demand for protection.

    “There are concerns that China’s economy will continue to be weak and obviously these companies will continue to have challenges because of that,” O’Rourke said.

    To be sure, some of the demand for puts could be due to bearish traders coming late to the game, said Scott Wren, senior global strategist for Wells Fargo Investment Institute in St. Louis, Missouri.

    “Some of this may be due to people continuing to jump on the bandwagon even after the shares have sold off, and could be a contrarian signal,” Wren said.

    The Shanghai Stock Exchange has further restricted trading in ETF options last month to ensure smooth operation of the options market.

    Options can be used as a tool to place bearish bets on the market. (SD-Agencies)