NEW YORK (Reuters) - As U.S.-North Korea tensions escalate, traders’ positioning in a key South Korea exchange traded fund’s options has turned significantly more defensive this year versus recent trading history, data show.
Shares of the U.S.-listed iShares MSCI South Korea ETF are up 30 percent for the year, and on pace for the best year since 2009. The broader iShares MSCI Emerging Markets ETF is up 27 percent.
However, on Tuesday, the ETF’s shares fell nearly 1 percent, moving in concert with a weakening of the U.S. dollar and a decline in the U.S. benchmark S&P 500 stock index.
While news of potential miniaturization of a nuclear device by North Korea was cited in a Japanese Defense Ministry annual report earlier on Tuesday, the decline in global markets during U.S. trading hours coincided with a report from the Washington Post.
That report, citing U.S. analysts, said the country was now making missile-ready nuclear weapons. Market analysts however were not citing North Korea concerns specifically for the moderate weakness in the markets, although subsequent comments from U.S. President Donald Trump warning North Korea sent the ETF lower.
Options traders, however, appear to be bracing for a hit to the ETFs’ shares. There are currently 4.2 puts open for each open call contract on the fund’s shares, according to options analytics firm Trade Alert.
Puts grant the right to sell shares at a fixed price in the future, and are often used by traders as insurance against a drop in share price.
This measure of sentiment has grown notably more bearish since the beginning of April. More telling is the climb in skew, a measure of the relative demand for puts versus calls, said Mandy Xu, derivatives strategist at Credit Suisse.
“There is definitely more cautiousness being priced into the options market for South Korea,” Xu said.
While some of the defensiveness may be stemming from a wish to protect recent gains, political headlines may be causing some investors to reach for insurance, market watchers said.
“The ongoing geopolitical tension in the Korean peninsula, with North Korea successfully testing another ICBM weeks ago, is a risk that hangs over the market,” Xu said.
Late last month, North Korea said it had conducted another successful test of an intercontinental ballistic missile (ICBM) that proved its ability to strike America’s mainland, drawing a sharp warning from U.S. President Donald Trump and a rebuke from China.
Tensions have escalated in recent days and the U.N. Security Council unanimously imposed new sanctions on North Korea on Saturday over its continued missile tests that could slash the reclusive country’s $3 billion annual export revenue by a third.
Xu also pointed to a potential weakening in growth momentum for South Korea headed into 2018 and the South Korea ETF’s large exposure to the tech sector as reasons why investors may be turning cautious.
In June, Credit Suisse lowered the 2018 growth forecast for Korea from 2.6 percent to 2.5 percent.
Samsung Electronics Co Ltd alone accounts for about 23 percent weighting in the fund and Credit Suisse estimates that EWY has a 28 percent weighting in the semiconductor industry.
“It’s true that EWY has always had very high exposure to tech, but tech is getting more volatile recently,” she said.
To be sure, the positioning in the fund’s options is more suggestive of hedging activity rather than outright bearish bias.
“It’s interesting that the jitters haven’t translated to lower stock prices,” said Charles Sizemore, founder of Sizemore Capital Management LLC in Dallas.
“This suggests that investors aren’t exceptionally worried about an all-out war breaking out.”
Reporting by Saqib Iqbal Ahmed; Editing by Daniel Bases and Chizu Nomiyama
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