In its long march from the quotations of Chairman Mao to the quotations of the world’s stock markets, China has emerged as one of the greatest economic successes in the history of the world.
The nation has risen from economic nothingness to the world’s second-largest economy in about 50 years—and it is still growing. During the first quarter, as the Covid-19 pandemic began to end, China’s economy grew 18.3%, compared with America’s 6.4% growth. Euro-zone economies shrank.
Most people eagerly invest in fast-growing economies, but China’s Communist government scares many investors.
In mid-April, China’s regulators gave 34 internet companies a month to “correct anticompetitive practices” or else face punishment. The move startled investors and introduced another hard-to-quantify investment risk.
In the U.S. and Europe, investors are comfortable enough with government intervention in financial markets that many now believe central banks protect the stock market against declines.
Yet this comfort with government intervention disintegrates in China. International investors generally don’t understand or trust China’s leadership, despite China’s profound economic success.
(ticker: PDD), a Chinese e-commerce company experiencing extraordinary growth. Pinduoduo uses technology to let people join forces to buy items. Group prices are lower than what people would pay if they acted alone. Available items range from food to everyday household goods.
Pinduoduo’s name is a play on the Chinese characters for “together” and “more.” In the company’s marketing materials, Pinduoduo is represented as “together more savings more fun.”
Unfortunately, owning Pinduoduo stock recently hasn’t been much fun, as China’s government scrutinizes the nascent digital economy.
The company’s American depositary receipts are down 30% this year, compared with a 5% gain for the
exchange-traded fund (ASHR).
Though Pinduoduo reported strong earnings on Wednesday, the stock fell 5.5%. But opportunity may exist amid the weakness.
With Pinduoduo at $123.57, aggressive investors can sell the October $120 put option for about $12 and buy the October $125 call option for $13.50. The “risk reversal” play costs $1.50 and positions investors to buy stock at $120 and participate in gains above $125.
During the past 52 weeks, Pinduoduo’s stock has ranged from $59.56 to $212.60 and is up 105%.
The put strike reflects confidence that the $120 price range, tested in early May, will continue to provide a durable support level. Should it buckle, investors will own the stock—at which point they could switch the strategy and sell upside calls to incrementally reduce risk and generate income.
This approach expresses faith in Pinduoduo’s business—and a belief that China’s leaders are only threatening to kill the chicken to scare the monkey, to cite a Chinese saying. The uncertainty the government has created could create opportunities for patient investors with an appetite for volatility.
Xi Jinping, China’s leader, may use his powers to control companies. But his government needs businesses, and foreign capital, to finish the economic miracle and help China avert a demographic time bomb that would probably create challenges that would be difficult for any leader to contain.
Steven M. Sears is the president and chief operating officer of Options Solutions, a specialized asset-management firm. Neither he nor the firm has a position in the options or underlying securities mentioned in this column.
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