Corners of China's Market Without 10% Limits Are Going Nuts

(Bloomberg) -- As China’s stocks surge, some traders are finding ways around limits on how much shares can move each day.

One method is convertible bonds that pay a regular coupon and can be exchanged for underlying stocks, but aren’t restrained by rules capping daily gains and losses to 10 percent.

“When the stock market is in a good mood, sharp rising and falling of convertibles may happen,” said Zhongliang Tuo, an investment manager at Cinda Securities Ltd, adding that he doesn’t recommend investors join in trading driven by whims of the market.

Take East Money Information Co., a financial data website with the third-biggest weighting in the ChiNext Price Index. While the stock hit the 10 percent limit on Monday, the company’s convertible bonds that had no such strictures jumped 20 percent.

The bonds snapped their three-day streak of gains on Tuesday, falling 7.1 percent as volume surged. The shares rallied 5.1 percent.

Corners of China's Market Without 10% Limits Are Going Nuts

Equity-linked notes from Shenzhen SGD Information Co., a maker of communication equipment, tumbled 26 percent on Tuesday, all but reversing a 36 percent rally the previous day. The shares, which had been limit-up the previous three sessions, fell 0.8 percent.

The surge in the convertibles on Monday “priced in expectations of further upside room for the shares,” Cinda’s Tuo said.

Both notes are trading at a wide conversion discount to their underlying securities, meaning it is cheaper to buy the bonds and convert into stock than it is to buy the stock outright. Difficulties shorting Chinese securities make it hard to take advantage of the potential arbitrage, especially for investors based overseas.

There are precedents to such reactions.

“A surge in certain convertible bonds also happened in 2014-2015, in the A-share bull market,” Yu Jingwei, a fixed-income analyst at CITIC Securities in Beijing, said in a phone interview.

Option activity has also surged on exchange-traded funds tracking mainland Chinese stocks, with the volume of contracts tied to the Shanghai-listed China 50 ETF hitting a record high on Tuesday.

Corners of China's Market Without 10% Limits Are Going Nuts

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