Hong Kong Exchanges and Clearing (HKEx) has unveiled plans to introduce new functionality for trading synthetic futures based on five active stock option classes.
The new initiative, which is pending regulatory approval, will launch on 9 May and will enable the use of synthetic futures strategies using China Construction Bank, China Life Insurance, China Mobile, HKEx and HSBC stocks.
An HKEx source said the initiative was a response to market feedback, with both institutional and retail brokers already indicating interest in trading synthetic futures. “But we think retail investors might need more education to thoroughly understand this new combination trading function in our stock options market,” the source said. “These synthetic futures are another way to enhance trading and capital efficiencies in our marketplace.”
Stock options account for more than half of HKEx's derivatives market turnover and trading was up 34% in the first two months of 2011 over the same period last year. About 75% of stock options trading on HKEx's derivatives market is by market makers or proprietary traders, with retail (15%) and institutional (10%) business accounting for the remainder.
The standard combination order function may be extended to other stock option classes, subject to market demand.
A synthetic futures strategy is a stock option combination consisting of two option legs. A buyer of synthetic futures purchases a call option and sells a put option with the same underlying stock, strike price and expiry date, whereas the seller of synthetic futures sells a call option and buys a put option with the same features.
The standard combination trading function that HKEx plans to introduce will allow investors to price synthetic futures as a package, thereby reducing execution risk.
According to HKEx, synthetic futures enable their users to manage delta exposure in stock options portfolios, help investors reduce their initial capital outlay and decrease the margin required in a hedged options portfolio with netting capabilities.
“We believe synthetic futures are an effective way for investors to manage delta exposure in stock options portfolios and they may help investors in reducing capital outlays in options-related trading activities,” said Calvin Tai, HKEx's head of trading. “This will be something new for our stock options market so we would like to remind investors that they should be fully aware of the features and risk exposures when using synthetic futures.”