By Belinda Cao – Jun 16

Options traders are paying the most in two months to protect against drops in the largest Chinese exchange-traded fund in the U.S. on concern a local money-market cash crunch will deepen a slump in Asia’s biggest economy.

The cost of three-month puts on the iShares FTSE China 25 Index Fund (FXI) soared to the highest since September last week, option data compiled by Bloomberg showed. The 4.3-point premium of puts over calls was the widest since April 17. The Bloomberg China-US Equity Index of the most-traded Chinese stocks in the U.S. slumped the most in four months last week, led by a 16 percent drop in Yanzhou Coal Mining Co.

The Hang Seng China Enterprises Index declined the most in a month last week after Morgan Stanley joined banks from UBS AG to Barclays Plc in lowering predictions for China’s economic growth. The Finance Ministry failed to sell all of the debt offered at an auction for the first time in 23 months and the one-year interest-rate swap climbed to the highest level since 2011 as banks hoarded funds, causing a cash squeeze in the interbank market.

“People are pretty nervous about what we’ll find out once liquidity is withdrawn,” Derrick Irwin, a portfolio manager of the Wells Fargo Advantage Emerging Markets Equity Fund, who helps manage $10.9 billion of assets in Boston, said June 14. “We haven’t seen action from China’s central bank and there’s curiosity from investors on what happens to the liquidity from the Federal Reserve as well. Markets that have really thrived on large amounts of global liquidity have struggled.”

ETF Plummets

The iShares China ETF plunged 4.7 percent last week in New York to $33.98, the steepest slump in a year. The Standard and Poor’s 500 Index lost 1 percent for the week to 1,626.73 as investors scrutinized economic data to determine whether growth in strong enough to prompt the Fed to scale back stimulus measures before its two-day policy meeting this week.   FOR THE COMPLETE BLOOMBERG LP STORY, PLEASE CLICK HERE