Options trading gathers momentum after record level of activity

"The link is definitely positive for China as this shows the will of the authorities to further open up the market," said Marco Montanari, Hong Kong-based head of passive asset management at Deutsche Bank AG, last week.

"International investors aren't that familiar with the Chinese A-share market so they invest in ETFs to gain macro exposure to China."

The PBOC has just reduced the one-year lending rate by 0.4 percentage point to 5.6 percent, effective on Saturday. The rates cut comes amid signs of deepening economic slowdown.

Factory production rose 7.7 percent in October from a year earlier, the second-weakest pace since 2009, while the inflation rate held at the lowest level since January 2010.

"Broad loosening in China will have a huge stimulatory effect on an economy that is already structurally in a far better position than at the beginning of all previous loosening cycles," said Douglas Morton, head of Asia research at Aviate Global. "The rally to come should be large."

The main beneficiaries are business borrowers, Bloomberg North Asia economist Tom Orlik wrote in a note. State-owned enterprises, real estate developers and local government investment platforms will be able to tap new loans at lower rates to refinance existing borrowing and fund new projects, the note said.

While the rates cut could fuel a short-term rally in Chinese equities, it is too early to conclude that the Chinese economy has bottomed, according to Pictet Asset's Pauline Dan.

"The feel-good factor will be there for the next three months," she said. "We probably have not seen the worst in the Chinese economy. There are still pockets of weakness that haven't bottomed yet."

Even as the Shanghai Composite Index climbed to a three-year high on Tuesday, six of the past seven cuts to interest rates and reserve requirement ratios have been followed by declines in stock prices over the next two months.

The last time the PBOC lowered lending and deposit rates, in July 2012, the benchmark index fell 7.4 percent.

Valuations on Chinese equities are among the lowest in major markets, with shares on the Shanghai Composite Index trading on Monday at 10.3 times estimated earnings and Hang Seng China Enterprises Index at 7.4 times.

Those compare with 17.2 times for the Standard & Poor's 500 Index and 16 times for the MSCI All-Country World Index.

While China's economy is poised for the weakest expansion since 1990, investors should not be too concerned as along as the world's most-populous nation avoids a hard landing and pursue further financial reforms, according to Macquarie Funds Management.

"The market's hand is off the risk-off button and now leaning firmly on the risk-on button," said Sam Le Cornu, senior portfolio manager at Macquarie Funds Management in Hong Kong.

"We're always going to get volatile monthly data. We don't think we're going to get a hard landing as there would be a lot of stimulus. The Stock Connect is a landmark development. People need to be patient and have a long-term view to see its full effect to be realized."