Friday, 20 September 2019


When light goes down, I see no reason
For you to cry. We've been through this before
In every time, in every season,
God knows I've tried
So please don't ask for more.
~ "Carrie"

Gross Profits : RM1,750
Return on Investment (ROI) : 12%
Duration : Intraday

At the risk of turning into a Hong Kong blog covering Hong Kong things only, our foray into trading Hang Seng index warrants continues. We've written a few lengthy posts on this topic, from the broad and simple to the narrowly complicated.

This particular trade was only notable for the fact that it was down to pure luck. Yes, it happens sometimes. We try to make peace with this.

While we are proponents of the 2:1 reward-to-risk ratio, we can stretch the thresholds a bit when our trading stake is small. Given that we were dealing with the most volatile trading instrument on Bursa Malaysia, sometimes we fail to follow our own rules. We're only human.

Below is an illustration of our purchase point, and why we were willing to temporarily ignore our tight stop loss thresholds. 

The rationale for this trade is simple. The 'gap up' as seen below is an indicator of bullishness. So we started building a stake. At the time, the Hang Seng was in the doldrums and has been for a fair number of weeks due to a confluence of negative factors, mainly the Hong Kong protests and a recent downturn in global markets. 

Since the trade was done, the index has jumped by more than 1,000 points.

The gap open in the Hang Seng encouraged us to stay invested. There was a decent decline in the markets of about 0.4% or so in the opening hours of trading on 5 September 2019. Over a 40-minute period, we managed to build a stake totaling 70,000 put warrants.

HSI-H6Q, the put warrant in question, actually fell steeply after we got in as the market suddenly stages a strong recovery. It was down 19% at its worst point, from a nice peak of 23 sen to 18.5 sen. Our temporary paper losses were in the RM1,000 plus range as of 10AM as the market continued rallying. (Editor's Note : remember that the put warrant correlation is inverse : a rising market means a deterioration in the value of our put warrant position)

At this point, we were faced with two options: dump everything or add to the position. This is where we have to admit that we were not abiding to the rules. If we had a threshold for an exit, that point had passed. 

In our minds, we had already absorbed the paper loss as a real one. Guided by instinct, we decided to grow the position at 18.5 sen with a purchase of 25,000 warrants. A reminder, though : instinct is always a lousy excuse for not following the rules.

You can see below that this bold move has a happy ending, but we will explain our thinking for this trade while admitting that luck played a prominent role in the outcome of this trade.


Here's a list of the myriad ways in which we were wrong. 

This was considered a mean reversion trade. Having gained an astonishing 4% the previous day, our wager was actually on a decline in the Hang Seng; perhaps by 1.5%. As you can see in the charts, we were completely wrong about that. 

We were wrong that we did not set aside solid thresholds as viable stop loss points. In effect, we underestimated the volatility of the index, exposing us to that 19% paper loss. 

We were wrong about the direction of the market and followed our biases. A large upwards move in the Hang Seng can mean either of two things : capital flows are well and truly back in, or that it was just a temporary bounce. We thought it was a bounce, and we erred in our judgment spectacularly.

One of the reasons we wanted to be contrarian in the first place was due to the very sharp fall in H6Q the day before. As you may be aware, this was due to Carrie's (bless her!) announcement that the government is proposing to withdraw the much maligned extradition bill. As it turned out, it was a bloody poor timing to be contrarian. Since 4 September, the index has pretty much gone up and up.

Back to the morning of the 4th at 10AM. Shortly after, the price and volume movement in H6Q was enough reason for us to stay in. At the aforementioned 18.5 sen level, our expectation was for the warrant to return to 20 sen, in effect creating a profit buffer of sorts for this newly assumed stake.

Given that H6Q closed at 21.5 sen the day before, we know that there is a strong tendency for the warrant to return to status quo levels. This is called mean reversion. 

As it so happens, the warrant returned to 20 sen levels shortly before the midday break. We were roughly breakeven at this point, covering our entire paper losses. 

The chart below shows the price fall in H6Q on 4 September as well as the price activity on the 5th: the warrant indeed closed at breakeven. 

In effect, our profits were down to our success in catching the trade at its extremities. Somehow we ended up buying some of the put warrant intraday lows (18.5 sen) and managed to sell at close to intraday highs (23 sen).

As you can see here, something happened during the midday break that allowed us to be bailed out, at a nice profit, by the 2:30PM re-opening. The put warrant made a 'gap up' move, and we quickly got out. For the rest of the day, it slowly descended back to 21.5 sen. 

So what made the markets jump? Well, it's this. Derivatives trading was halted for the rest of the day due to a cyberattack. Traders in Hong Kong could not place their orders. The futures market was closed but the cash market (the actual index) was still quoted*.

Between 1PM and 2:30PM, as the Hang Seng reopened for the afternoon trading session, the index plummeted due to this anomaly. Bursa Malaysia is not open during this time period of course, so the activity was only fully reflected by 2:30PM. Put warrants hit their intraday highs as the index plunged to intraday lows. We got out.

This was just a random occurrence that put us in a favourable position. We had a semblance of a trading strategy and all that, but the truth is we were bailed out by the market gods. That's it.

*technical explanation : the futures market is where large institutional traders do their hedging activities, sometimes to catch small short term profits.. They may buy a basket of Hang Seng component stocks and hedge that by selling short index futures. When the futures market shuts down, there is a risk that the position is imbalanced. A halted futures market means that some traders cannot get out of their intraday positions. To offset that risk, they may be driven to sell that basket of stocks bought earlier. In large enough sizes, this selling can potentially drive down the Hang Seng index itself. This is just one probability; the market ended up rebounding pretty quickly after this temporary selling.

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