A-share Derivatives Market Update:Facilitating diversification and innovation for brokerages,comment

Event:

    On Friday, Jan 9, the CSRC unveiled the Pilot Measures for Stock Option Trading and its relatedpolicies. At its press conference, the regulator also announced that the Shanghai Stock Exchange hasbeen approved to undertake trading of the SSE 50 ETF option, effective from Feb 9 2015.

    Comments:

    Market impact from the launch of the SSE 50 ETF optionLaunch of stock options is conducive to increase the AUM and liquidity of the underlying asset.

    Launch of stock options is conducive for the development of the financial market. Looking at theimpact from the CSI 300 index futures on CSI 300 ETFs, launch of financial derivatives is conducive toincrease the AUM of underlying products and make them more liquid.

    Launch of stock options will prompt diversification of financial products. Investment strategiesfor hedge funds will diversify further after the launch of the SSE 50 ETF option, while financialproducts for general investors will also increase with more trading strategies becoming available.Absolute return and quantitative hedging strategies will expand further, which will facilitate thedevelopment of asset management products and allow further diversification of financial products.

    Launch of stock options will boost the valuation of blue-chips. Although the launch of stockoptions is unlikely to alter market fundamentals, it will boost the valuation of blue chips over thenear-term. As domestic investors are accustomed to go long, demand for call options will significantlyoutweigh puts, which will boost the valuation of blue-chips over the long-term.For example, the HangSeng Index rallied 7% one week after the HKEx launched equity options in 1995, individualunderlyings including HSBC Holdings also rose continually. As the covered call strategy will enhancereturns compared with holding long positions in the ETF only, such strategy made available by thelaunch of the SSE 50 ETF option will make the underlying more attractive.

    Initial contribution may be limited, but in the long term the launch will drive diversification ofthe domestic investment bank industry, and will have profound impact on a number ofbrokerages’ businesses. Despite the already heightened activity in the index futures market,contribution to the businesses of brokerages from ETF options is likely to be limited in the initial periodamid the prudent stance adopted by the regulator. However, as the market’s risk managementcapacity increases and available option products become more diversified, options will promptdiversification of investment bank business models over the long-term, and have profound impact on anumber of brokerages’ businesses.