Advanced Search

The story appears on

Page B7

September 1, 2014

GET this page in PDF

Free for subscribers

View shopping cart

Related News

Home » Business » Finance Special

Stock index options set to add heft to the burgeoning derivatives market

By Hu Xiaocen | September 1, 2014, Monday | Print Edition

CHINA is preparing to launch stock index options on the China Financial Futures Exchange, using the Western model of market makers instead of a previously considered order-driven system.

Zhang Xiaogang, director of the research and development department at the financial futures exchange, told Shanghai Daily in August that the bourse was ready to launch the new derivative instrument — options on the CSI 300 stock index. He didn’t disclose the timetable for the new product, saying only that it will be subject to regulatory approval.

The China Financial Futures Exchange is a venture established in 2006 by the stock exchanges of Shanghai and Shenzhen, the Shanghai Futures Exchange and commodity exchanges in Dalian and Zhengzhou.

In 2010, it launched its first product, CSI 300 index futures — a derivative based on the performance of 300 stocks traded in the Shanghai and Shenzhen bourses. The instrument is also known as the Hushen 300 Index futures — taking Shanghai’s commonly abbreviated name “hu” and Shenzhen’s “shen.”

With the introduction of index futures, Chinese stock markets allowed investors to make money from both rising and falling prices. It’s part of China’s market deregulation program, aimed at making domestic markets more open and international.

Index options, along with the index futures, provide a combination of tools for investors to bet on the movement as well as the volatility of the market.

Development of derivatives trading in China has significantly lagged that of advanced markets.

Nicholas Ronalds, president at investment advisor Rhofinancial LLC, said in an article on the website of World Federation of Exchanges that the ranking of the most active listed equity index products globally is dominated by options, hence the potential for options in China is enormous.

The China Financial Futures Exchange has been running a simulated trading program for the past 10 months. According to Zhang, 145 broker-dealer firms and 135,000 investors have participated in the simulation, with 73 market makers facilitating the trade.

An average of more than 2.5 million options contracts changed hands each day, with a notional value of 28.9 billion yuan (US$4.7 billion).

By contrast, the Australian Securities Exchange’s ASX SPI 200 options had a trading volume of 388,450 contracts exchanged for the whole of 2013, according to the Australian bourse’s website.

In Hong Kong in the second quarter, the volume of Hang Seng Index options was 1.7 million.

“Stock index options are one of the most actively traded options derivatives worldwide,” Zhang said. “They are a standardized instrument that serves the risk management needs of companies and investors. And between the bourse and the investors are the intermediaries that will use the instrument to make innovative portfolios to meet the needs of both.”

Zhang said that the market-maker system is one of the most important elements in the derivatives market. Market makers ensure liquidity on both the buy and sell sides. The spread between buy and sell prices is the profit they take.

At some bourses, market makers are compensated for the risks they take by zero or lower trading fees.

The China Financial Futures Exchange has spent a lot of effort to educate and train the financial firms designated as market makers for CSI 300 options. So far, over 30 institutions are qualified to act as market makers for the new derivative in the pipeline. These financial firms include banks and brokerage firms with no previous experience in trading options. In essence, they have built their market making systems from scratch, eyeing future arbitrage opportunities.

The margin calculation system is another important feature of options trading.

Zhang said a portfolio margin system was used in the simulated trading exercise. It is a risk-based system widely used in advanced markets to reduce trading costs and improve trading efficiency.

Zhang and his team have been studying plans and building a technical system for what is called SPAN, a standardized portfolio analysis of risk system that uses complex algorithms to compute margins. The system, after calculating the margin of each position, can shift any excess margin on existing positions to new positions or existing positions that are short of margin.

Another fundamental tool for efficient index options trading is the volatility index, which is compiled based on the prices of different contracts. The reading reflects market sentiment and can serve as an important reference for market regulators, said Zhang.

In the simulated trading, the index was updated every minute during trading sessions, which was previously changed once a day before July.

Finance Special


 

Copyright © 1999- Shanghai Daily. All rights reserved.Preferably viewed with Internet Explorer 8 or newer browsers.

沪公网安备 31010602000204号

Email this to your friend