The unexplained slump follows a similar drop for the Hang Seng Index in May.
Chinese stock-index futures plunged by the daily limit before snapping back in less than a minute, the second sudden swing to rattle traders this month.
Contracts on the CSI 300 Index dropped as much as 10% at 10:42 a.m. local time, recovering almost all of their losses in the same minute. More than 1,500 June contracts changed hands in that period, the most all day, according to data compiled by Bloomberg. The China Financial Futures Exchange is investigating the tumble, said people familiar with the matter, who asked not to be named because they aren't authorized to speak publicly.
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The unexplained slump follows a similar drop in Hang Seng China Enterprises Index futures on May 16 in Hong Kong, a move that heightened anxiety among investors facing slower Chinese economic growth and a weakening yuan. Volume in China's stock-index futures market, which was the world's most active as recently as July, has all but dried up after authorities clamped down on speculative trading during the nation's $5 trillion equity crash last summer. Tuesday's volatility had little impact on the underlying CSI 300, which rose 3.4%.
“Liquidity in the market is really thin at the moment,” Fang Shisheng, Shanghai-based vice general manager at Orient Securities Futures Co., said by phone. “So the market will very likely see big swings if a big order comes in.”
Mr. Fang said the sell order that triggered the plunge probably came from a hedging account, a designation for investors who use futures to offset risks from their holdings in the stock market. Such accounts are exempt from limits on opening more than 10 contracts in a day, according to CFFEX rules announced in September. June contracts changing hands during the tumble on Tuesday were valued at 1.43 billion yuan ($218 million), based on the day's settlement price, data compiled by Bloomberg show.
Chinese policy makers restricted activity in the futures market last summer because selling the contracts is one of the easiest ways for investors to make large wagers against stocks. Volume shrank by more than 90% from its peak after officials raised margin requirements, tightened position limits and started a police probe into bearish wagers.
An official at CFFEX in Shanghai said he couldn't comment on Tuesday's move and refused to give his name.
Some international traders with negative views on Chinese stocks have shifted their wagers to offshore markets. Short interest in one of the largest Hong Kong exchange-traded funds tracking mainland shares has surged fivefold this month to its highest level in a year, according to data compiled by Markit and Bloomberg. The CSI 300 has dropped 15% this year, versus a 2.2% gain in the MSCI Emerging Markets Index.
While sudden price swings are hardly unique to Chinese exchanges, the country's markets have come under increased scrutiny in recent months as MSCI Inc. considers adding mainland shares to its international indexes. Recent measures to curb trading halts and clarify beneficial ownership rules have improved the country's odds of inclusion to 70%, Goldman Sachs Group Inc. analysts wrote in a report on Tuesday, which was one of the factors behind the market's rally. MSCI will announce its decision next month.
