Options on Korea Exchange’s Kospi 200 Index are the most traded ETD contracts in the world by volume with an average of 15m contracts changing hands every day. Such success is surprising, given the exchange’s limited product range of 74 contracts and the fact that South Korea’s economy, though among the world’s 20 largest, is about the same size as those of Mexico or the Netherlands.
The Options contract of the Kospi 200 was a roaring success from day one. When the contract was introduced in 2004, KRX had hosted 12.2m trades the previous year. Fast forward one year and the exchange recorded 2.58bn trades.
Of those, the Kospi 200 Option accounted for 2.51bn, and that success has continued since then. Many point to the lower contract size as the reason behind its success. However, relative the local economy, they are still sizeable. Each options contract is sized at W100,000 times the index, now about 250. That means each is for a notional amount of around $22,000 per contract, significant more than the GDP per capita of $17,000.
The brisk trading of Kospi 200 Futures and Options is the result of several factors said Alex Choi, broker at Daewoo Securities in Seoul. Most important is the high participation of retail investors about 30% in the Kospi 200 Futures and Options, making it unlike any other market in the world.
Koreans are now financially well-educated enough to trade futures and options, compared to other countries, Choi said. The Kospi Options relatively small size also makes them suitable for retail traders.
Emmanuel Faure, head of business development and sales for HSBC Futures Asia, suggests another reason for the options success that with few retail-friendly instruments available at KRX, the Kospi Option became the default speculative instrument.
Another factor in the markets favour has been Korea’s status as the country with the largest number of internet connections per person in the world. About 80% of households are connected to the net, putting the derivatives potentially in reach of a mass audience.
High speed internet and investors friendliness to internet-based trading make individual investors participate in the options market actively, Choi concludes, adding that these retail investors understanding of software is as sophisticated as their knowledge of derivatives.
Open for business
Foreign firms account for around 40% of activity on the exchange. There are regulatory obstacles to foreign participation, but compared with some of its Asian neighbours, Korea is easily accessible and a land of opportunity.
The Korean government has over the last few years pressed for more international firms to be active in its exchange-traded markets. To become a member of KRX, either as a clearing member, non-clearing member, or a non-clearing special member, a firm must obtain permission to commence derivatives trading from Koreas Financial Supervisory Commission.
Toby Lawson was appointed managing director of Newedge Hong Kong, says that this ease of access has driven interest from high frequency traders in recent years: “We see a lot of activity in the Kospi that is driven by high frequency trading.
“There is a small notional but the volumes are huge. Kospi is quite unique in some ways in that you have a large retail base trading options. Against that the market makers and options experts see huge opportunity. There is good liquidity and they are trading options directionally.
“The opportunities for high frequency trading have led to a lot of co-location from firms looking to take advantage of the liquidity.”
KRX has made great strides in recent years to increase international participation in the market. Last year Eurex began to offer trading in Kospi 200 options when the Korean markets are closed. The Eurex KOSPI Product is a daily futures contract based on the KOSPI 200 options traded on KRX. The futures contracts expire at the end of each trading day and any open positions are transferred to KRX to establish a position in the Kospi 200 option.
Since launch on 30 August 2010, the Eurex Kospi Product has steadily increased its daily average volume – peaking at a record level of 108,000 contracts in August 2011 – the first month with ADV above 100,000 contracts. Additionally, a daily record was achieved on 4 August 2011 with 207,953 contracts changing hands.
Meanwhile, CME Group has got its own cooperation project with KRX, covering Kospi 200 Futures, not options. Since November 2009, the US exchange has offered after-hours access to the contract, hosted on the CME Globex electronic trading platform by routing orders to KRX’s Unified System for Global trading (USG). Firms can trade the contract only through firms that have KRX membership.
Replicating success
The success of futures and options in equity indexes in East Asia is not limited to the Korea Exchange. One thousand miles south across the South China Sea, the Taiwan Futures Exchange is enjoying a record year in trading in futures and options on its Taiwan Stock Exchange based contracts.
Taiwan’s market is big and getting bigger. Like Korea’s, its biggest contract is an index option – the Taiex Option, which was traded 95.7m times in 2010. That’s still only a third of the volume every month in the Kospi 200, but it’s more than any other contract in Southeast Asia.
The corresponding futures contracts were traded 25.3m times last year, and the mini version, the same size as the option, 13.9m times. This year over 30m futures and 120m options will trade in the index on the exchange representing a near 30% increase on 2010.
These futures are directly competitive with the Singapore Exchange’s MSCI Taiwan Index Futures, although for the moment, there seems to be plenty of room for both products. The Taiwan Futures Exchange also offers MSCI Taiwan contracts, but they are little traded. SGX also offers trading on Nikkei 225 futures with 28.76m contracts trading last year and contracts on India’s “Nifty 50” index.
Equity index trading in the frontier markets of Malaysia and Thailand is also booming. Currently only futures are recording any notable liquidity on the two markets with Malaysia offering futures on the Bursa Malaysia Kuala Lumpar Composite Index and Thailand on the SET50 Index. However, trading in options on Thailand Futures Exchange is growing with 120,000 contracts expected to change hands this year.
“We expect growth in Malaysia and Thailand and also in Indonesia but at this stage I don’t think we will see the kind of growth we saw in Korea or India,” said Lawson.
Enter China
However, it is the launch of trading in futures on the CSI 300 Index in China that has dominated investor interest over the past 18 months. The move to begin trading on the newly launched China Financial Futures Exchange last year marked a new age of derivatives trading in the country with the market opening up to Qualified Financial Institutional Investors.
The market opened its doors in April 2010 and by the end of the year 45.87m contracts had changed hands. The China Securities Regulatory Commission is eager to raise the open interest ratio. At the end of September just 37,768 contracts were outstanding, though 4.94m – 130 times that number – had been traded during the month. This very low ratio suggests that most trading is short term speculative interest, rather than hedging.
The CSRC has been so worried about a speculative mania that in June 201 the exchange told brokers to limit the amount of trading their clients could do each day. In response to the crackdown, monthly trading fell down to around 4m contracts, from a peak of about 7m in July and August.
“If you are a QFII you can access the China market but there are quite a lot of restrictions over who can trade it. It is not being promoted as a retail product,” said Lawson.