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China's index futures traders are still betting jittery markets will fall further even as Beijing tries to prop them up, making the futures markets a key battleground in Beijing's campaign to restore market confidence.
Index futures, established in China in 2010, give investors a way to hedge risk, and also provide short-sellers another way to make money in a falling market. They are also closely watched by investors as an indicator of sentiment, and that has become a major problem for Beijing this week.
Traders note that China's major future contracts, in particular the CSI300 contract maturing on Friday afternoon, are pricing at a discount to current market levels, which implies those investors will need to pull down the index further or face losses.
And none of the futures contracts, which go as far forward as December, are pricing the CSI300 index close to where it would be if the Shanghai Composite Index, which shares many component stocks with the CSI300, recovered to 4,500 points, which is seen as the target level for when government intervention will cease.
That means the market is betting against the government, which is trying to push indexes back up after a near one-third drop, and has begun cracking down on futures markets and futures traders, accusing some of "maliciously shorting the market".
"If you look at today's performance, the bears have not admitted defeat," an official at CITIC Futures said late on Wednesday. "If they can influence retail investors and trigger another round of panic selling, knocking indexes below key support levels, there's still a chance of a comeback."
"Ultimately, it's a matter of which side has more money."
Beijing, however, is not relying on money alone, preferring to suppress futures trade through regulatory measures. It has made it more difficult to borrow for trading futures, limited trading in some contracts, and has sent the police to investigate individuals and institutions accused of illegal trading behavior, which some see as a way to intimidate short sellers.
Yet futures for the CSI300 index all closed lower on Wednesday, with the contract maturing on Friday pricing at 2.7% below the index's latest level. Many contracts on the more volatile small cap CSI500 index dropped by their 10% daily limit.
"CRITICAL MOMENT"
The struggle highlights Beijing's difficulty in wooing investors back into a battered stock market.
A multi-pronged effort - easing monetary policy, adding liquidity, freezing initial public offerings, and imploring investors through state media campaigns to "defend the stock market" against short-sellers - stemmed precipitous stock market losses late last week.
That puts Beijing's credibility on the line, along with the savings of those who rallied to the patriotic call.
But shares closed down on Tuesday and again on Wednesday.
A trader at one major Chinese bank said Friday would be critical for the "national team" trying to prop up the market - including banks, brokerages and mutual funds that have committed to buy until the Shanghai index hits 4,500, a level last seen around June 25.
Wang Feng, CEO and founder of hedge fund firm Alpha Squared Capital, said futures pricing reflected enduring bearish sentiment on stocks.
"Index futures are being used mainly as a risk-hedging tool now. People who have stocks on hand are shorting index futures to hedge their risks. Many investors are waiting for a rebound to sell their shares. So there's still a lot of selling pressure in stocks."
STATE-BACKED 'LONGS'?
The irony is that the futures market, and other derivatives, are supposed to play a key role in market reforms, alleviating the volatility Chinese markets have seen in the last six months.
By allowing investors to insure against sharp downward moves, it can encourage them to take more aggressive long positions, and indeed the CSI futures markets have proven extremely popular, with CSI300 futures seeing more turnover than US S&P 500 futures in May.
However, Beijing may be sacrificing the futures market to save the wider market. Some traders think the next step might be regulators buying and selling futures to influence prices more directly, given the failure of administrative means.
That would further expand the scope of China's market intervention, which began by targeting blue chip shares, then spread to buying small caps.
Some think it has already started.
Last week, there were significant orders - more than 30,000 long contracts were opened - at CITIC Futures, countering bearish market bets worth over 40 billion yuan ($6.44 billion), the unnamed brokerage official said, adding the money seemed to be coming from state-backed investors.
China's securities regulator could not immediately be reached for comment.
($1 = 6.2082 Chinese yuan renminbi)
