KWEB: Our Bearish Strategy Explained (Technical Analysis) (NYSEARCA:KWEB)

Technical Analysis

Recently, we went short the KraneShares CSI China Internet ETF (NYSEARCA:KWEB) through the purchase of the bear put option strategy. In this article, we will explain our reasoning for why we went short the fund and how we will manage the position going forward.

First, if we go to the intermediate chart, we see that shares have rallied almost 70% over the past 14 weeks, which is a feat in itself. This sharp rally in KWEB caused the fund’s 10-week moving average to rally above its 40-week counterpart on pretty strong volume. However, there are two technical points that confirm that KWEB as of yet has not confirmed a new bull market.

1. The intermediate MACD histogram has already begun to turn over which means that the up-move we have seen over the past 3+ months is losing some of its potency. In fact, the last time when the intermediate MACD histogram turned over (back in June of last year), shares fell pretty sharply to the downside over a four-month period.
2. In order to confirm a long-term bull run has begun in an exchange-traded fund (“ETF”), we needed the fund to make higher highs over a considerable period of time. A sustainable period of higher highs moves the long-term average (Something like the 200-week moving average) in an upward direction. As we see below, despite the convincing rally over the past 3+ months, KWEB’s 200-week moving average has yet to turn upward.

Although the above chart helps us in the analytical process, it is not useful for trading purposes. In terms of timing trade entry, shorter-term charts are more advisable. As we see from KWEB’s daily chart below, we already have sell signals by means of crossovers in both the MACD & the ADX trend indicator. However, since our strategy is directional in nature, we need the ADX trend-following indicator to start to turn up in order to add to our existing bearish position.

Low Implied Volatility

One thing that is in our favor in terms of strategy is KWEB’s low level of implied volatility as we see below. Buying options when implied volatility is low (KWEB currently has a 52-week IV rank of 8). Therefore, any significant down move should be beneficial for put sellers from a vega standpoint. In fact, the longer one goes out in time with something like naked puts or puts spreads, the more an increase in volatility will affect the position (for the better) due to longer-dated put options having a higher vega.

Holdings

Although KWEB currently has 34 holdings within the fund, Tencent Holdings Limited (OTCPK:TCEHY) & Alibaba Group Holding Limited (BABA) make up over 20% of the weighting in the ETF. In fact, if we pull up a full breakdown of the different sectors in KWEB, we see that the communications sector (from which Tencent belongs) and the consumer cyclical sector (from which Alibaba belongs) make up over 76% of the fund. Therefore, both of these stocks’ fundamentals are a solid read on where KWEB will trade going forward.

Tencent

Although Tencent has enjoyed a blistering rally over the past few months, there are question marks on whether its strong profitability trends can continue. Tencent’s net profit margin over the past four quarters surpasses 30% but forward-looking earnings revisions have disappointed over the past three months in particular. Suffice it to say, if current trends continue, we will see the company’s already overextended valuation multiples continuing to climb (Which inevitably will put pressure on the share price before long)

Alibaba

Alibaba’s valuation has also become loftier in recent months with shares now trading with a forward GAAP earnings multiple of 32.35 and a forward sales multiple of 2.22. To justify these valuation multiples, the Internet giant needs far higher top-line growth rates to essentially drive the income statement forward. The year-over-year top-line growth rate of a mere 5%+ for example needs to be considerably improved for shares to continue to trade higher here.

Risks

The benefit of using options (Purchase of Puts or Put-Spreads) over shorting the fund outright is that one’s risk is essentially unlimited when shorting the ETF. In fact, short sellers have a defined profit potential, but upside risk is unlimited. On the contrary, one’s risk when either buying puts or put-spreads is limited to what one spends initially on the various contracts, which means you cannot lose more than is initially spent.

Apart from the volatility argument made above, option buyers also have the benefit of controlling more shares of KWEB with far less buying power. Therefore, the risk/reward setup is much better on the options side, although one needs to be ultra-careful about not letting options finish out of the money by expiration, If this happens, the options expire worthless and a 100% loss is realized.

Furthermore and if we return to the implied volatility chart above and focus on the horizontal red line (70%+), this corresponds to KWEB’s 52-week IV average, which tells us the following. What this means is that KWEB is expected to trade between a range of approximately $10 per share & $53 per share over the next 12 months (The current price of the fund is $31.51). Obviously, this volatility far outweighs the average in the ETF space, which is another reason why investors may refrain from shorting this fund.

A word of caution, however, to long-holders of KWEB who believe shares of the fund remain dirt cheap and will rally aggressively from here. More interest rate cuts by the government would indeed spur more economic activity, but we believe these potential moves have already been priced in on the technical charts at this stage. Despite KWEBs recent short-term rally off its lows, the long-term trend remains in bear-market territory due to how Covid will continue to cast a cloud over the economy for some time to come. Suffice it to say, even if the likes of Tencent & Alibaba start to hit it out of the ballpark regarding their earnings going forward, investors will continue to remain far more cautious for some time to come.

Conclusion

Therefore, to sum up, recently we went short the KraneShares CSI China Internet ETF (KWEB) through the debit put strategy. We now await a trend to develop which may see us add to our position in due course. Let’s see what upcoming sessions bring. We look forward to continued coverage.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.