Asian Equities Derivatives Strategy
Keep hedging during 1H09
The global outlook remains extremely uncertain in 2009 – the key question is
how long and how deep will the US recession be? What we are sure is that the
global easing have been never so well co-ordinated and co-operative. Although
the aggressive interest rates cut can cushion the economic downturn, the
ultimate problem cannot be solved over a short period of time. Deleverging,
clearing of toxic assets and restructuring of the financial sector may take years.
While equity valuation has come down to very tempting levels, earnings remain
at risk and there maybe some valuation traps. Analysts are not bearish enough
and we are expecting the downward earnings revision will be behind the
selldown. Disappointing economic and earnings figures will be the focus during
1H09, and will likely send the market down again, and re-testing previous lows
remains a possibility. A general myth is the market will recover as a result of
global easing, thus, volatility will gradually move down the path of the economic
and equity recovery; the key question is when? Since our global economist is
expecting the US to enter five quarters of recession between 1Q09 to 1Q10,
thus, a meaningful economic recovery will begin in 2Q10. If equities are moving
six months faster than the economy, a recovery uptrend will start in 3Q-4Q09.
Therefore, hedging during 1H09 is highly recommended. If taking a longer-term
view, short volatility will be a rewarding theme, and as such we suggest shorting
long-dated volatility.
Key Strategies: (indicative pricing)
􀂄 STRATEGY 1: Hedging Tools For Asia Pacific Equities
⇒ Long Put Spread, Knockout Put, VMH (Vega Minus Hedge) or
Lookback Put on regional indices
􀂄 STRATEGY 2: China Is Relatively Better
⇒ Long Outperformance Call with 130% knockout on HSCEI over
the other indices
􀂄 STRATEGY 3: Short Covered-call To Enhance Returns
⇒ Short 3M 110% Call on HKEx (388 HK), CNOOC (883 HK), CCC
(1800 HK) and China Railway (390 HK)
􀂄 STRATEGY 4: Long Call Spread on Fundamental BUYs, Financed
By Short Put Spread
⇒ Short 3M 95/80% Put Spread and Long 3M 105/120% Call
Spread on China Shenhua (1088 HK), CM Bank (3968 HK)
􀂄 STRATEGY 5: Get Exposure In Asia Via Asia Sector Swap
⇒ Asia Pacific Infrastructure, Telecoms and Banks Baskets
􀂄 STRATEGY 6: Distressed Asia Basket
⇒ Long big and liquid under-valued plays in Asia
􀂄 STRATEGY 7: China SAFE Basket
⇒ China SAFE Limited to invest in HK listed Chinese shares
􀂄 STRATEGY 8: Directional Play On Volatility
⇒ Hedge for volatility drop or short long-dated volatility

I. Asia ex-Japan Outlook
Some Asian economies will be dragged down into negative growth;
earnings remain at risk …
Our global economist is expecting that the US economy will enter into negative
growth for five quarters starting from 1Q09 to 1Q10, with a concrete economic
recovery beginning in 2Q10. If the stock market recovers about six months
faster than the real economy, a recovery uptrend will start from 3Q-4Q09. Thus,
1H09 will remain tough and hedging for the first half of 2009 is necessary. For
Asia, our economists remain optimistic for full year’s economic forecast,
however, there is a chance for some Asian economies to dip into negative
territory for one to two quarters in 2009. Also, we believe the downward
earnings revisions are not enough and some more cuts in earning estimates are
likely to happen after the 2008 full year or 1Q09 results.

Psychologically, most investors and traders have probably lost confidence to
invest or betting the ups or downs, and indeed they have been suffering from
the pain of deep losses due to many unexpected events. Wealth shrinkage
resulting from collapsing stock market and commodities, falling currencies and
bonds, as well as mark-to-market loss in property, will make investors reluctant
to invest. The psychological recovery will take longer than the stock market
recovery. Although the aggressive rate cuts from the central banks globally
would prompt some investors who rely on treasury and saving deposits to invest
in riskier assets. However, the chance for the economy to dip into deflation is
high, thus, saving interest rate will stay positive in real terms. As such, riskier
assets will remain a minority portion of investment. In addition, as the poor
sentiment remains, we are not going to see liquidity improve substantially at the
initial stage of a rebound. As not foreseeing a decent upside potential, investors
will continue to be cautious until a more confirming signal from the economic
front appears.

Overweight China will be a consensus strategy …
As things work on a relative basis, funds are likely to lean towards Chinese
equities. China has high chance to outperform because the Chinese
government aims to sustain over 8% y-y growth at least for the next few years,
while some other countries are either struggling to escape from recession or
even have solvency risk. Overweight China among the Asia ex Japan or the
global emerging perspectives will be a consensus strategy for 2009. China, with
a large surplus, and having the 2nd largest foreign reserves globally, is the
country that can stimulate economic growth effectively. Besides, the first batch
to rally are always those big caps, we did recommend the China SAFE basket in
December on expectation that the China SAFE Investment Ltd will diversify from
the US treasury to invest in Hong Kong listed H-shares and red chips as they
are of higher potential to make decent returns over a long-term horizon.