Sunday, 24 March 2019



Gross profit : RM1,000
Return on investment (ROI) : 9.76%
Duration : Intraday, 80 minutes

For us, the market's been quite boring lately. We have missed rallies (that we think are unsustainable) and lost money (when we go into such rallies since we don't know any better). Trading volumes have largely improved since, but only due to speculative positions in certain oil and gas counters.

We took a step back and tried to reassess things. The current market environment? OK-ish, but uncertain to continue. We are fundamentalists at heart; where is growth coming from?

Last week, the US Fed finally explicitly said that there will no longer be planned rate hikes for the foreseeable future. This 'dovish' view failed to boost the markets. Why? We think it's because everything has already been priced in since October. US markets have rallied by 15% since; so did Asia's key markets.

No matter how speculative we seem, our world view is grounded in the fundamentals. We see news items like 'China's exports fall 20% in February' and can't help but view the market in a bearish lens. 

Global markets have already priced in the 'dovish' Fed stance. A weaker dollar may be good for emerging Asia but to what extent really? Central banks in Asia can afford to cut rates further? Yawn; we don't think that's such a compelling angle.

Take Malaysia as an example. It's clear that the KLCI has severely underperformed global markets so far this year. Political and stability risks continue to persist. Only a foolish company would expand their capacity now by making acquisitions, expanding landbank, growing their workforce etc.

There are many foolish companies, but none are keen to spend right now. An interest rate cut makes borrowing more appealing, but who wants to spend so quickly? Malaysia can suddenly undergo a huge political turmoil at any moment; that's what you face when your prime minister is a 93-year-old.

But we digress. Today's post is on the Hang Seng, which we have some experience in. The angle is simple: we trade in anticipation of momentum. The Hang Seng index has struggled to stay at the 29,000 level recently. Good news have dried up. Yet another trade war related fakery won't keep this ship afloat. As we have been for a long time, we are negative on the index.

Toppishness in the Hang Seng Index. Daily chart from early February until 22 March.

As we have said previously, index linked warrants are inherently risky to trade. They can gain 10% in value in the morning before losing 20% in the afternoon session. To avoid pain, there are strict rules to be followed.

To maximise the chance of succeeding, here's our abbreviated list of 'shit that's necessary to happen if we were to trade Hang Seng put warrants'. 

Oh, and in case you're a newbie, put warrants profit when the markets fall. Given our market views, they are of course a very important part of our strategic thinking.

So, the rules:

1) Get a catalyst
2) Charts must be good
3) Markets should have reacted weakly to supposedly 'good' news
4) Buy into weakness, always.

(2) is already covered; anyone with a basic understanding of charts should be able to see the struggles of the Hang Seng index since earlier this month. (3) is the news about the Fed above; markets reacted, but not strongly. There was a distinct lack of enthusiasm, replicated by the Asian markets.

(1) is as follows : on 21 March, Tencent (the gaming + WeChat + everything company) posted its worst quarterly profit drop (of 32%). The company, given its size and prominence, and its stock commands outsized influence on the Hang Seng index. Indeed, like Apple and the Dow Jones, Tencent's stock price movement dictates the Hang Seng's trajectory.

There may be other catalysts, but we chose this one to highlight this fact: you have to look for things that actually impact the index, and in this case it's just these two - Tencent's stock, and the overall global market sentiment. Both were not good, which gives us confidence to pursue a bearish view. 

(4) is basically a remedy for getting hit squarely in the face. Since we know about a put warrant's potential volatility, it is important to trade only when the stock is in a losing position. This will give you a better buffer/margin of safety  in case the volatility is much stronger than expected.

But to do this you basically have to buy into the opposite direction. Call it micro-contrarianism; since our time period is short, we are not going for the crazy gains. We set modest profits and a predetermined timeline to see if this trade works out.


You may ask; there are so many index warrants on Bursa. Which one to trade?

The answer is : whichever suits your wallet (same answer to: how many shares should I buy?). But do pay attention to day-to-day liquidity and average trading volumes. Choose something that is neither too liquid (they  tend to be priced cheaper, perhaps at the 10 sen range) or too illiquid (more expensive but don't see regular trading action). 

Our preference: actively traded index warrants priced in the 20-35 sen range. We are familiar with them and are comfortable with putting a large position. It also helps to have them in your watchlist for observation before you decide to commit; we are in the love-before-marriage camp.

For this trade we chose HSI-H6F, a reasonably volatile put warrant with a long remaining tenure (warrants nearing expiry tend to be far more volatile, and there are no guarantees of liquidity).

So, we did set some parameters for this trade angle, also abbreviated:

1) Trade the put warrant.
2) Have to exit position within the day. This angle cannot be carried overnight.
3) Reasonable size to buy : 50,000 lots or more.
4) Target as usual : 10% returns 
5) Priority is on hitting the profit target, rather than maximising it.
6) Only buy if the price is below yesterday's close (to get that margin of safety)

To put it another way, the put warrant would have to be weaker than the day before for us to go in. This means that the market would be rallying, and we're going against the grain. Understanding market dynamics is the key to making this work; you better have damn good reasons to anticipate that rally to suddenly stop, moving the prices (and profits) in your direction. It takes time, trial and error to have this skill. A lot of all three, actually.

Anyway, HSI-H6F fell to 20.5 sen on 22 March, a 1 sen drop from the previous day's close. We bought into it at that price as the put warrant turned weaker, hitting a bottom of 20 sen.

About an hour later, prices began to move in our direction. The put warrant hit its break-even (same price as yesterday's close) of 21.5 sen. This is the beauty of getting that margin of safety; it gives us the chance to dispose at break-even (with a RM500 profit) or, if our angle is wrong, to sell back at 20.5 sen, costing us nothing except hurt pride and intraday brokerage fees. 

This is what you have to understand about momentum: when you're right about Thing 1 (the market reversing), there's a better likelihood that you will be right about Thing 2 (there will be enough movement to hit our profit target). We designed this trade so that it can plausibly hit our predetermined profit target of 10%. This requires HSI-H6F to hit 22.5 sen, a 1 sen increase from its break-even. If it does, we exit.

The eventual outcome? We made a thousand ringgit within just over an hour. Sure, the put warrant kept going up, but here's the last lesson today: always trade the market at your own terms.

We don't care if the put warrant kept going up to 30 sen; a different trading plan would be needed. We are happy with the gains, and potentially the chance to replicate these trades in the future. Five of these and our lunch money for the next 5 years is assured (Ha!).

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