Billionaire fund manager Bill Ackman last week went public with his bet that the days of the 39-year peg of the Hong Kong dollar to the US dollar are numbered.
The ripples on the derivatives product march suggest he’s not alone, as “macro” trading – or betting on big global shifts – is coming back into fashion and the prospect of solving a compensation standard for a relatively low risk rekindles a consistently unsuccessful trade.
Most fundamental analysts say such bets are foolish, justify the city’s still massive reserves and support from China.
But they can be relatively cheap and even commendable, peg remains intact, and they provide insurance against improbable but not impossible changes in events, such as a sudden explosion in China, a devaluation, or a geopolitical chill.
“For me, the peg of the Hong Kong dollar is like a delayed bet, or delay, against China,” said Diego Parrilla, who heads Quadriga Igneo, a $240 million fund designed to take advantage of the March turmoil. .
“You take advantage of the extreme complacency of the march,” he said. “The drop is limited to the premium spent… I risk very little and I can earn a lot.”
Saba Capital founder Boaz Weinstein is also positioned for a break in parity, and said on Twitter that the gain could be “greater than 200 to 1”.
The cost and size of these positions are unclear, but Ackman and Parrilla said their bets are placed using options.
Options are contracts that include an upfront fee, allow investors to bet on the price movement of assets without the risk of losses beyond the upfront fee, and there are signs that these bets are picking up.
A measure of the spread, or skew, between puts and calls in the options market has hit its highest level in about three years in favor of U.S. dollar call options, suggesting that bets against the Hong Kong dollar are getting a bit more plentiful.
The Hong Kong dollar has been pegged in a tight range between 7.75 and 7.85 per greenback for nearly four decades. Its stability and fungibility are the main foundations of Hong Kong’s success as a financial center and a hub for money flowing in and out of China.
China rarely comments on parity, but in 2014 its cabinet said the government would “reservedly support” Hong Kong in maintaining parity and stability in the city.
The Hong Kong Monetary Authority (HKMA) maintains the peg by moving interest rates in line with the United States, and through monetary interventions, which drain liquidity from the system and are designed to drive up prices. local rates until entrees stabilize the currency.
Trades that bet against the peg, perhaps encouraged by the spectacular examples of peg breaking in the past in places like Switzerland or Argentina, seem to resurface every time the US interest rate rises. , and investor reasoning varies.
One possible way out, rather than a clean break, is a rebound in the dollar’s Chinese currency, the yuan.
Still, Chinese and Hong Kong officials have never hinted a change is on the cards, and analysts don’t think the unease outweighs the usefulness of the peg.
“As long as capital controls remain in China…Hong Kong still offers a good window for money inflows and outflows,” said Redmond Wong, Greater China strategist at Saxo Markets. “I don’t see why there is an immediate trigger…to change the status quo.”
Even bad bets on breaking parity can be laudable, and protected by parity itself.
If, rather than options, traders are betting against the peg using contracts – another contract in which the parties agree to exchange currencies in the future – the position can make money if the Hong Kong dollar does not increase. Losses would also be capped by the strong end of the currency band.
In the short term, the market moves against this style of trading as local interest rates and the Hong Kong dollar expand.
But some investors still see value in longer chance contracts. A one-year forward contract may still be commendable if spot prices are below about 7.78 per dollar, or the currency changed Friday, a year from now.
“The far-end futures market is still down on US rates higher than Hong Kong rates,” said Mukesh Dave, and chief information officer at Aravali Asset Management Singapore, which in theory should contain the gains of the Hong Kong dollar.
The cost of a notional one-year US$1 million call option with a strike price of HK$7.95, for comparison, is about 55 basis points or $5,500, according to Dave.
Although more expensive to start with, and without the prospect of a profit if parity holds, bettors seem to prefer the options route and claim that it offers a better risk/reward ratio.
John Floyd, who manages his own hedge fund from New Jersey and an options recommendation to sell uncovered the yuan and the Hong Kong dollar in February, said a futures position is dangerously exposed if China ends the peg with a conversion into yuan a stronger price than the currency band.
“The only way to express this trade that both controls downside risk and allows upside profit…is through outright long options exposure.”