Exchange-traded funds feel the pinch from bearish investors

United States options traders have never been so bearish on Chinese mainland's shares amid concern that expensive valuations will offset government efforts to revive investor confidence after a $4 trillion rout.

Puts protecting against a 10 percent decline in the Deutsche X-trackers Harvest CSI 300 China A-shares fund cost 1.8 times the price of calls betting on a 10 percent increase, according to three-month data compiled by Bloomberg.

The cost of the bearish options has surged as much as 75 percent in the past three weeks. The ETF, with about $600 million in assets, has declined 21 percent from a June 12 peak, mirroring a selloff in the benchmark Shanghai Composite Index.

Even after the slide, the median trailing price-to-earnings ratio on mainland bourses is 66, higher than in any of the world's 10 largest markets. Valuations have been propped up by a flurry of regulatory measures, including a suspension of initial public offerings, restrictions on bearish bets in the futures market and a ban on sales by major shareholders.

"Investors are skeptical about the long-term success of the intervention measures and whether they can trump underlying economic fundamentals," said Mandy Xu, a New York-based derivatives strategist at Credit Suisse Group AG. "Investors are still worried about a renewed sell-off."

The Shanghai Composite Index rose 0.9 percent on Monday. Government data for the second quarter released last week is yet to ease concern about a deceleration in the world's second-largest economy.

Gross domestic product rose 7 percent in the three months through June from a year earlier, the National Bureau of Statistics said on Wednesday, unchanged from the first quarter and beating economists' estimates for 6.8 percent.

Policymakers are said to have made as much as $483 billion of funding available for a government agency to support the stock market among their latest efforts to prop up equities, Bloomberg News reported on Friday, according to industry sources.

"The panicked response of the authorities has led to market distortions," said George Hoguet, a global investment strategist at State Street Global Advisors. Implied volatility, a key gauge of options prices, was 56 percent for bearish contracts on the Deutsche A-shares ETF last week, compared with 32 percent for bullish calls.

The fund gained 3.2 percent on Friday to a two-week high of $43.46, pushing its gain for the week to 0.5 percent. Investors pulled $147 million from the fund in the five trading days, a third straight weekly outflow, according to data compiled by Bloomberg.

Investors are also paying up for protection against declines in Hong Kong-traded funds tracking mainland stocks. The cost of puts on the iShares FTSE A50 China Index ETF surged more than 160 percent from a March low to a high on July 8, according to data on one-month options compiled by Bloomberg.

The price for bullish contracts on the largest overseas A-share ETF rose about 130 percent during the period. For the CSOP FTSE China A50 ETF, the cost to use derivatives to hedge surged to a record earlier this month. The Shanghai Composite Index has rebounded 13 percent from a three-month low on July 8, while its 30-day historical price volatility has stayed near 60 percent, the highest since 1996.

The stock rout has not eroded the outlook for further gains in the mainland stocks as government support measures boost investor confidence and monetary easing spurs economic growth, according to Kinger Lau, a Hong Kong-based China strategist at Goldman Sachs Group Inc.

He predicted this month the large-cap CSI 300 Index will rally 27 percent from the close on July 7 over the next 12 months. The gauge has risen 5.7 percent since then.

While China reported a better-than-projected GDP growth, concerns about the quality of the expansion remain. Financial services grew 17.4 percent in the first half of the year due to the stock rally, while real estate languished and agriculture grew at about half the overall economy's pace. Outstanding loans for companies and households rose to a record 207 percent of GDP at the end of June, up from 125 percent in 2008.