China's Surprise Stimulus Shocks Global Markets, Catches Options Traders Off Guard

By Matt Amberson | ORATS

China sent shockwaves through global markets yesterday with the announcement of stronger-than-expected stimulus measures. As Asian markets surged, with China and Hong Kong equities rising more than 4%, traders scrambled to adjust their positions. Prior to the announcement, options traders were largely betting against any major upside, a strategy that was quickly tested as the market reacted bullishly.

Traders Were Heavily Short Pre-Stimulus

Before the stimulus announcement, traders had built significant short positions in the iShares China Large-Cap ETF (FXI), a key proxy for Chinese equities. The chart of FXI shows that traders were primarily positioned for limited upside. According to the options data, the Net Dollar Delta and Total Short Dollar Delta indicate that traders were largely short on Chinese stocks, expecting muted price movements.

The FXI options market yesterday showed a short delta of -123 million, meaning traders were betting against substantial price increases. This bearish sentiment was prevalent among traders as they anticipated the Chinese economy to continue underperforming. Selling call options was a popular strategy, as it allowed traders to collect premiums in what they expected to be a low-volatility environment.

Call Selling Strategy Dominated the Market

One of the clearest signs that traders were unprepared for the bullish market move is the large short call positions taken just before the announcement. A significant example of this is in row 1 of the FXI options data, where 90,000 contracts were sold at the 29.5 strike price, expiring on October 18th, 2024. Traders who sold these calls were betting that FXI would remain below $29.50, aiming to collect the premium from selling the options.

This strategy—selling call premiums—was based on the assumption that the market would remain stagnant or decline slightly. Traders were willing to sell calls at the 29.5 strike, expecting limited upside for Chinese equities. This, however, proved to be a miscalculation as the stimulus package sent markets soaring, leaving these short call sellers vulnerable to significant losses.

The Stimulus Surprise

China’s announcement of its stimulus package caught most traders off guard. The measures, which included significant infrastructure spending, tax cuts, and monetary easing, were stronger than anticipated. As a result, Chinese stocks surged, driving up the price of FXI and pushing it toward key resistance levels.

In the FXI chart, we see that prices spiked, heading toward the double-top resistance at $29. This price level has been a historical point of resistance for the ETF, and traders who had sold calls at the 29.5 strike were caught off guard as the market rallied closer to that level. The sudden market move caused a reversal in fortune for many traders who had shorted calls, leading to notable losses.

Losses Pile Up for Short Call Sellers

This illustrates the inherent risk in selling call options—while it can be profitable in low-volatility environments, a sudden market-moving event can quickly reverse profits. The stimulus package created a perfect storm for short call sellers, who were expecting a calm market but instead faced sharp price increases that put their positions underwater.

The Fed's Plans Complicated by China’s Move

The global market implications of China’s stimulus package are significant, particularly for the Federal Reserve. U.S. markets, including the S&P and Nasdaq futures, saw modest gains of 0.1% following the announcement. However, traders remain uncertain about the longer-term effects of China’s stimulus on global inflation.

One of the primary concerns is whether China’s stimulus will fuel global inflation, particularly through rising demand for commodities and raw materials. If inflation picks up, it could force the Federal Reserve to reconsider its monetary policy. Traders had been expecting the Fed to ease interest rates, but rising inflation might prevent this, keeping rates higher for longer.

This uncertainty is reflected in the market's muted response in the U.S. Futures oscillated between gains and losses, with traders unsure of how to position themselves amid the potential inflationary pressures China’s actions could trigger. The Federal Reserve’s path toward easing monetary policy may now be less clear, adding a new layer of complexity to an already volatile market environment.

FXI Options Activity Signals Trader Confusion

The FXI options data underscores the confusion and surprise experienced by traders. Large call spreads and short call strategies dominated the market prior to the stimulus announcement. Many of these positions, particularly the short call positions, are now in jeopardy.

For example, traders using strategies like the short call spread (seen in row 3) were betting on limited upside. This strategy involves selling a call at a lower strike and buying a call at a higher strike, capturing the premium if the underlying stock stays within a certain range. However, with the market rallying, these positions are at risk of being breached, further adding to trader losses.

What Comes Next for Traders?

In the wake of China’s surprise stimulus, traders are reassessing their positions. Those who were short and had sold call options now face the challenge of managing losses, while volatility is expected to remain elevated in the near term. The sudden price movement has caught many by surprise, but the situation also presents opportunities for those able to pivot quickly.

For traders still positioned in FXI, monitoring key technical levels, such as the $29 resistance, will be critical. If FXI breaks through this level, it could signal further bullish momentum, leading to more pain for short sellers. Additionally, the trajectory of U.S. inflation and the Federal Reserve’s response to these global economic developments will likely influence market sentiment in the coming weeks.

Conclusion

China’s stronger-than-expected stimulus package has upended global markets, catching options traders off guard and triggering significant price movements in FXI. Traders who had shorted calls, expecting minimal upside, now face losses as the market rallied sharply in response to the stimulus. With inflationary concerns looming, the Federal Reserve’s plans may also be impacted, adding uncertainty to an already volatile environment. For now, traders are left to navigate the fallout and reassess their strategies as the market adjusts to this new reality.