Three months after China’s $5 trillion stock-market crash, the fallout from unprecedented state intervention is visible almost everywhere you look.
The country’s stock-index futures market is a shadow of its former self, with volumes shrinking more than 99 percent after authorities blamed the contracts for exacerbating the rout. Equity trading has dropped 46 percent after policy makers restricted computer-driven strategies and banned stock sales by major shareholders. Regulatory curbs on short selling, meanwhile, have contributed to a 71 percent tumble in the bearish wagers.
Yet in one corner of the Chinese stock market untouched by the clampdown, business is booming. Options, introduced in China just nine months ago, are now thriving as traders use the derivatives as a substitute for futures and short sales. The number of outstanding contracts on the China 50 exchange-traded fund — the first and only options available on mainland bourses — has more than doubled over the past five months.
“Investors are moving into the options market because the index futures market is basically dead,” said Li Jingyuan, the head of securities investment at Shanghai Zhaoyi Asset Management. “These investors need a market to do hedging.”
The shift shows how Chinese stock traders are adapting to curbs that have made it difficult to execute all but the simplest of investment strategies. While regulators haven’t spelled out why they left options alone during the rout, Li said the market was probably viewed as too small at the time to warrant intervention.
Now, though, it’s starting to look a lot more meaningful. Open interest in China 50 ETF options surged to 506,810 contracts as of Tuesday, up from 223,552 when the stock market peaked in mid-June. Most of the gains have from puts, which give buyers protection against market declines. The number of such contracts has increased about fourfold since the end of June.
More than 225,000 China 50 options changed hands on Tuesday, versus 22,975 for futures on the CSI 300 Index. That’s a turnaround from June, when average daily volume in options was 89 percent below that of CSI 300 futures, the world’s most active contract before a clampdown that included increased margin requirements and stricter position limits.
“It is entirely rational that volumes should only continue to increase, especially since margin requirements have become relatively more onerous on other products,” said Andrew Scott, the head of flow, strategy and solutions at Societe Generale SA.
Like any security on mainland exchanges, options come with their own set of regulations. Trading is limited to institutions and individuals with at least 500,000 yuan ($78,392) in their accounts, who must pass three tests on their options knowledge before becoming eligible to trade. Individual investors can hold no more than 50 contracts at any one time.
The crash in share prices has probably delayed plans for expansion of the options market to new underlying securities, such as single stocks or equity indexes, according to Zhaoyi Asset’s Li.
“That’s something that will happen in the future, not now,” Li said. “The regulators are already very scared by derivatives, namely what happened in stocks and the index futures market during the rout, and they aren’t likely to develop any new products.”
For now, China 50 ETF options look like one of the best ways for mainland investors to hedge their equity holdings or make big bets on where the nation’s share prices are heading.
Current positioning in the contracts suggests traders are turning more optimistic. The cost of betting on a rally has climbed relative to bearish wagers amid growing confidence that China’s monetary stimulus will put a floor under the nation’s economic slowdown. The so-called skew on one-month contracts increased to the widest in almost three months on Nov. 12.
“Investors think the Chinese government will try all their best” to support a 23 percent rally in the Shanghai Composite Index from this year’s low, said Castor Pang, the head of research at Core-Pacific Yamaichi Hong Kong. “That’s why options are skewed toward the bull market.”