Here’s one for the ‘don’t try this at home,’ file. Yesterday’s post on how the dollar’s decline makes China’s red-hot stock market look like a classic short candidate—and my decision to buy puts on a China ETF—brought the following response from Richard Saler, a “former fund manager specializing in international equities”:

“I'm sympathetic to your short idea. I would short a chart like that as well. However, the FXI is made up of H shares not the A shares which the chart shows. Although the FXI has had a big run it is nothing like the A shares. The valuation while stretched is not absurd like A shares either. With the government trying to cool the A share market it is now experimenting by letting some citizens invest abroad in H shares. This program is likely to be expanded and the arbitrage of A vs H shares could continue, since several A shares also trade at steep discounts in Hong Kong. This liquidity driven market could continue longer than you think. As a value investor I certainly wouldn't buy the FXI but given the current technical factors and liquidity this index could still have substantial upside. If I could sell the Shanghai A shares I would but that's not available. I think your chart and comments were misleading since FXI are H not A shares and right now that's a big difference. Any thoughts?"

I had a lot of thoughts, of course, the main one being why the hell doesn’t the ETF explain in big red letters that there’s a valuation difference between its Chinese stocks and the home-grown variety. Another thought: this is why we have investment pros, to keep the unwary novice (which I clearly am when it comes to Asian stocks) from paying too much tuition at Bonehead University.

But now what to do? Apparently there’s no way for Americans to directly short the A shares, which seems to leave three choices: 1) Sell the puts I bought just yesterday and wait for arbitrageurs to equalize the values of A and H shares, 2) sit tight and ride it out in the hope that that, valuation differentials notwithstanding, the China bubble bursts in the near future, 3) sell short-term puts against my long-term puts to generate cash while the equalization process plays out. Richard’s take on number 3:

“As to your shorting FXI and writing out of the money puts. It is certainly a method but shorting the index will tie up a lot of capital which is costly. Also if the index continues to run sharply your premium won’t make up for your short losses. I suggest you keep track of expensive and high beta H shares and when they start to break down technically you can decide to play. Or buy a few way out of the money puts. If the FXI keeps running buy a few more. Eventually this index will fall sharply but from what level I have no conviction. Hope this helps.”

It does help, thanks Richard. I’ll sleep on it and let you know.







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