A New ETF Lets You Take Advantage of China's Big Stock Selloff

NEW YORK (TheStreet) -- China's stock bubble finally appears to be bursting this week, and now investors can take advantage of the market selloff.

Not surprisingly, it's a bearish ETF that profits off market declines. It's called the Direxion Daily CSI 300 China A Share Bear 1x Shares (CHAD), and it debuted just this week on the New York Stock Exchange.

The Direxion ETF tracks the blue-chip China Stock Index 300, composed of 300 stocks that trade on either the Shanghai or Shenzhen exchanges. But because it's a bear fund, the ETF bets against those stocks, so the fund gains when the CSI falls.

On Friday, the CSI 300 plummeted 6% and ended the week down more than 9%, the index's worst performance in seven years. The Direxion China Bear ETF, meanwhile, was trading nearly 5% higher on Friday.

The risk with the CHAD ETF is that if the CSI 300 Index snaps back and rallies, the ETF will tumble. The CSI 300 Index has more than doubled in the past year, indicating that there have been plenty of days when it has climbed 2%, 3% or more. If those days return, the CHAD ETF will fall by the same amount.

Investors expecting such a rebound could look at the Deutsche X-Trackers Harvest CSI 300 China A-Shares ETF (ASHR), the largest China A-shares ETF trading in the U.S.

On the surface, the debut of a bearish China ETF seems like a risky proposition. After all, the top four ETFs in terms of year-to-date percentage gains -- and five of the top six -- are Chinese shares funds. But as this week has shown, mainland Chinese stocks can swiftly correct, and some investors are not waiting around for those declines to worsen.

Since June 8, investors have pulled almost $308 million from Deutsche bullish ASHR ETF, while yanking a combined $28 million from the Market Vectors China AMC SME-ChiNext ETF (CNXT) and the Deutsche X-Trackers Harvest CSI 500 China A-Shares Small Cap Fund (ASHS), this year's two best ETFs. The elevated valuations currently assigned to A-shares bolster the case for risk-tolerant traders to consider a fund like the CHAD ETF.

"Even more telling about the degree to which the A-share market is overheated may be the Hang Seng China AH Premium Index, which tracks the relative prices of 59 stocks that have both A- and H-share classes available. Theoretically there should be little difference since institutional investors can arbitrage between the two markets, but in reality practical constraints have A-shares now trading at a 40% premium vs. their H-Share counterparts, the largest since mid-2009," according to AltaVista Research.

The Hang Seng China AH Premium Index recently traded at its highest levels since 2009. Mainland Chinese stocks trade at an average of 256 times reported earnings, according to Bloomberg.

This article is commentary by an independent contributor. At the time of publication, the author held no position in the stocks mentioned.

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