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Hedge funds salivate over arbitrage trade in Alibaba's HK and US shares

Buying Alibaba's IPO shares while shorting a similar amount of its US stock could theoretically yield a return close to 5%.

Hong Kong

AN expected price gap between Alibaba Group Holding Ltd's Hong Kong and US shares is fuelling a colossal arbitrage trade.

In a Hong Kong sale of more than US$10 billion, the Chinese e-commerce giant may offer a 5 per cent discount to its New York-listed shares, according to media reports. Alibaba is scheduled to set a price on Nov 20 and start Hong Kong trading on Nov 26.

Several hedge-fund managers queried by ECM Watch are keen to take part in the arbitrage trade, which offers a relatively safe bet in a turbulent Hong Kong market. Buying Alibaba shares in the offering while shorting a similar amount of its US stock could theoretically yield a return close to 5 per cent.

Large Chinese companies tend to have very narrow price gaps between their Hong Kong shares and American depository receipts, Aequitas analysts wrote in a Wednesday note discussing the arbitrage trade.

"The only real money to be made from the listing will be the discount that it's offered at versus its US listing," analysts led by Sumeet Singh wrote. "As soon as the deal is launched, the long-short investors are going to want to hedge whatever they think they might get allocated by shorting the US listing." Some long-only Alibaba investors may also shift from their US positions to Hong Kong shares to capture the discount, the analysts wrote.

Still, there is a risk of not getting enough allocation of shares in the offering to offset short positions. And if the price gap unexpectedly widens, investors may need to move their Hong Kong stock to the US for short covering, raising their costs.

Alibaba's listing would be the world's largest this year if done before Saudi Aramco's gargantuan sale, according to data compiled by Bloomberg. BLOOMBERG

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