Option the Dragon: Stock Options set for launch in China

Written by Victor Fan || 20 Aug 2013

On August 6, 2013, Chinese securities companies received ‘the notice of preparing the initiating stock options full simulating trading works’ sent by the Shanghai Stock Exchange. This information implies that SHSE is already fully prepared for the launching of stock options. Although there is no clear timetable for launching the stock options, it is likely that they will appear in Chinese capital markets in 2013 or 2014.

Exchange traded stock options are new to Chinese capital markets and these derivatives provide a number of benefits. For one, both long and short-term trading are accessible and, similar to other derivatives such as futures, t+0 is allowed. Another benefit, which is an advantage over futures, is that leverage is provided but buyers can only lose the amount that they paid for the option. Options traders can also execute more complicated strategies through the combination of buying and selling call and put options, including straddles and spreads. Moreover, stock options are perfect hedging tools for individual stocks. Currently, Chinese stock index futures can only hedge the risks of the CSI 300 index and can not directly hedge non-systematic risks from individual stock options. And, despite providing leverage, security companies charge high transaction fees and interest rates for customers interested in selling short and buying long. Furthermore, the introduction of stock options comes with a high minimum threshold, which may largely change the structure of investors in the stock market by increasing the proportion of institutional investors. Thus the introduction of stock options may largely change the landscape of Chinese stock markets and may stimulate trading volumes.

However, there are also potential problems and doubts from the public that my come with the introduction of Chinese stock options. One issue regards the minimum threshold for investors of stock options. Some market analysts estimate that this threshold could be as high as one million yuan, which is higher than thresholds for index futures and securities lending services from securities companies. Currently, only 1% of accounts in the stock market can meet this requirement. Critics argue that stock options may serve as a tool to short the market by institutional investors and rich individuals, who may be in a disadvantaged position. But there are also analysts stating that the threshold may be lower, which would give normal individual investors a better opportunity to participate. The minimum threshold will depend on the final decision from CSRC.

Another problem has to do with the underlying stock that stock options are based upon. Currently, it seems as though only very large blue chip listed companies can enjoy stock options, so not all stocks can be optioned. Because large-cap stocks fluctuate less dramatically than small-cap and medium-cap stocks, the meaning of stock options may not be as transparent as in the fully opened western markets. But for institutional investors like mutual funds, as large-cap stocks take larger proportions of their shares, stock options may be an ideal hedging tool for stabilizing the performance of their portfolios. As current stock markets have adopted t+0 and t+1 trading, short-term day trade for hedging is not feasible. Thus traders may either choose longer-term hedging strategies or speculate through high-frequency intra-day trading.

Furthermore, large amounts of speculation in stock options may lead to dramatic fluctuations in stock prices. Similar to trades within A-share markets, the cost of short-selling is much higher than longing the stocks. So under the current unbalanced system, both hedgers and speculators may choose short in the stock options and the performance of A-share markets in the future may weaken. This has already been proven from the stock index future’s impact on A-share stock markets.

In conclusion, despite the risks, the launching of stock options is important for the development of Chinese capital markets.

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