UBS Research has updated its China internet investment themes and sector preferences following second-quarter earnings results. Given low volatility and negative skew conditions, UBS recommends investors go long through bullish call spread strategies on TRIP.COM-S, NTES-S, and PDD.

The Chinese internet sector concluded Q2 earnings season with divergent performance results and market reactions. Following earnings releases, UBS China Internet Research Analyst Kenneth Fong updated his sector outlook and refreshed top stock recommendations in his latest report. Despite downward revisions to 2025 sector earnings expectations due to increased investment by e-commerce giants, market sentiment remains optimistic with rising valuation multiples.

Kenneth highlighted five key sector themes:

Growth Divergence: Overall retail growth remains steady, but emotional consumption (gaming, music) continues to outperform online physical goods, while online physical goods outperform offline physical goods. Vertical sector leaders with stable competition and higher profit expectations are seeing earnings upgrades.

E-commerce Competition: Non-food category competition is expected to persist through Q4, with structural declines in user economics. However, profit impacts appear largely reflected in current market expectations.

Artificial Intelligence: Major internet companies continue deepening AI investments, with recent high-end GPU inventory sufficiency. Profitability is significantly improving across cloud computing, advertising, and vertical segments including video and gaming.

Regulation: Overall regulatory environment remains favorable. Anti-monopoly developments warrant attention, particularly in e-commerce.

Tariffs: Cross-border e-commerce is expected to accelerate as merchants clarify tariff impacts. PDD has resumed its fully-managed model in the US.

Kenneth's stock selection framework emphasizes AI monetization, emotional consumption, regulatory support, and strong fundamentals with catch-up potential. His current top picks are Tencent, TRIP.COM-S, NTES-S, Kuaishou, and PDD, focusing on vertical leaders and value positioning.

UBS highlighted Tencent and Kuaishou's upside potential in last week's report "Tencent and Kuaishou — Q2 Earnings Winners and Options Upside Plays." This week's report outlines attractive bullish options structures for TRIP.COM-S, NTES-S, and PDD.

TRIP.COM-S - Buy Rating: UBS Research View: TRIP.COM-S is recognized as the domestic travel industry leader with margin expansion potential and limited competitive risk. Its international business is expected to maintain strong growth momentum, while its stock remains undervalued amid intense market competition.

Options Strategy: TCOM and 09961's 2-month ATMF IV has fallen to approximately 31 vol, near three-year lows. Call skew has inverted with 2-month 100-105% F skew at -0.5 vol. Investors seeking protected long exposure can capitalize through call spread purchases.

Examples: Buy TRIP.COM-S 30Oct25 $595-690 (104.9-121.7%) call spread for $16.9 (3%), indicative pricing with spot reference $567, 31 Delta, maximum net payout 4.6x. Buy TCOM US 17Oct25 $75-85 (105.3-119.3%) call spread for $1.5 (2.1%), indicative pricing with spot reference $71.23, 28 Delta, maximum net payout 5.8x.

NTES-S - Buy Rating: UBS Research View: NTES-S is favored for its gaming business acceleration potential in H2, substantial new game launches in 2026, continued classic game recovery, and reasonable valuation.

Options Strategy: 2-month ATMF volatility at approximately 33%, in bottom decile over 3-year period following recent decline. 2-month 100-105% F skew has inverted, making call spreads attractive for adding long exposure with downside protection.

Examples: Buy NTES-S 30Oct25 $225-260 (106-122.5%) call spread for $6 (2.8%), indicative pricing with spot reference $212.2, 29 Delta, maximum net payout 4.8x. Buy NTES US 17Oct25 $140-160 (103.8-118.7%) call spread for $3.8 (2.8%), indicative pricing with spot reference $134.84, 32 Delta, maximum net payout 4.2x.

PDD - Buy Rating: UBS Research View: As Temu recovers from its most challenging period, supported by new cross-border model launches and continued expansion beyond the US, PDD is viewed as having significant upside potential.

Options Strategy: PDD's implied volatility declined significantly post-earnings. 2-month ATMF IV in low 30s, near three-year lows with flat upside skew. Investors seeking moderate upside opportunities between quarterly releases can utilize low volatility and flat skew through call spread strategies for protected long positions.

Example: Buy PDD 17Oct25 $130-145 (104.5-116.6%) call spread for $2.5 (2%), indicative pricing with spot reference $124.39, 27 Delta, maximum net payout 4.9x.