By Samuel Shen and Tom Westbrook
SHANGHAI/SINGAPORE (Reuters) - Shanghai Power Asset Management Co has apologised to investors and shut its arbitrage strategy after heavy losses, the latest China hedge fund bruised by wild gyrations in the market since authorities vowed to support the economy and hit growth targets.
Power Asset, which trades options to bet against outsized market volatility, lost more than $10 million over the past month, the strategy's biggest ever loss, as China's stimulus blitz -set off a furious stock market rally.
"Due to the major changes in market environment, our options strategy was maimed," Power Asset said in a statement, announcing a phase-out of the strategy, which manages roughly 400 million yuan ($56 million).
Its flagship fund under the strategy lost one-fifth of the value over the past month, according to its website, joining a slew of funds hurt by the markets' sudden turn.
"We feel deeply guilty, and sorry, for the loss suffered by our investors," Power Assets said.
Stock turnover and volatility broke records after Beijing announced its biggest stimulus since the pandemic on Sept. 24.
During the scramble for China stocks, options that offered investors the right to buy shares suddenly became extremely expensive, said Rajesh Manwani, head of markets and wealth management solutions for Asia at Julius Baer, stretching the market in a way he said was different from the usual pattern.
British hedge fund giant Winton, Beijing X Asset Management, Techsharpe Quant (Beijing) Capital Management and Shenzhen Chengqi Funds were among others sideswiped by the market's turn.
TAIL RISKS
That dynamic shift dealt a blow to hedge funds like Power Asset which had sold the suddenly popular "call" options at a much lower price.
Options arbitrage had been Power Asset's best-performing strategy, seeking steady profit from tiny gaps in pricing between derivative instruments.
An option contract gives the buyer the right to buy or sell underlying assets such as a stock or stock index, and its value reflects expected future volatility.
"When an option contract is under-priced, we buy; When it is over-priced, we sell," Power Asset founder Chen Pao told a roadshow in late July. The company uses one-month moving average as yardstick for rational pricing, he told investors.
"It's a strategy with high odds of winning. On a monthly basis, we won 90% of the time."
The caveat was the so-called tail risk from extreme events with small probabilities, which the company manages through swift loss-cutting and diversified investments, Chen said.
Other investors have likened the trade to picking up nickels in front of a steamroller and Robin Zhang, chief operating officer at asset manager Winfield Global Capital Ltd called it "very audacious."
"You're basically betting you win 95% of the time," he said. "But there's also a 5% chance you blow up."
That seemed to happen last month, when China's stock and commodities market surge caught the investors off guard.
Though the market has since calmed traders are bracing for more waves when Beijing eventually offers details of its spending package and as U.S. election results roll in.
Shanghai-based hedge fund manager Jason Zhang said investors can use a so-called straddle option strategy - which can profit if prices move in either direction - to wade through the uncertainty.
"If you don't know whether the market will rise or fall, but feel the move will likely be violent in either direction, this can be a good strategy."
Republican Donald Trump, in particular, is seen in financial markets as a frontrunner and likely to unleash volatility.
"If Donald Trump wins, tariffs and other threats would be inevitable, which will likely trigger panic" in China's already volatile market, said Ke Zong, former portfolio manager at Shangai-based hedge fund Mingshi.
"A cloud still hangs over many hedge fund managers who recently suffered losses from futures and options trading."
($1 = 7.1260 Chinese yuan renminbi)