July 22, 2014

China is preparing to launch equity index options on the China Financial Futures Exchange and single stock options on the Shanghai Stock Exchange. The move has been welcomed by market participants as providing more investment opportunities, while market operators and trade handlers see access to a huge and untapped market.

Initially, authorities had indicated that they would go with an order-driven market, not a market maker-driven market. Both the Options Industry Council and the Chicago Board Options Exchange have had continuous interaction with Chinese representatives through their educational programs, and OIC expressed the opinion that it would be sub-optimal to go order-driven only.

An order-driven market would likely lead to a lack of liquidity in certain options listings, including longer-dated contracts. Additionally, it might present a situation where there wouldnt be a counterparty to the trade at a reasonable price.

Alan Grigoletto, OIC

“All option markets in the US are market-maker driven,” Alan Grigoletto, vice president of education at Options Industry Council, told Markets Media. “You need to have both a bid and an offer, and there are exchange rules governing the percentage of the time that you are quoting as well as minimum contract size and the width of the spread. There are thousands of strikes in the US options market, including weeklies, quarterlies, monthlies, index, leaps, flex, et cetera.”

Exchange authorities have since reversed course and are going with a market maker model. With that, Shanghai Stock Exchange is currently holding a simulated options trading competition. The simulated training is being done with Horizon, a financial software company. The participants are futures companies and broker dealers plus a handful of non-Chinese market makers who are there to participate as well.

There is still uncertainty as to when the launch will happen. Initially, authorities had indicated that they guessed at being ready to launch as early as May of this year.

They really want to get this right and avoid the negative experience associated with warrant trading some time ago,” Grigoletto said. “They want to make sure that the options markets, the customers and the broker dealers are functioning well.”

One area which is a bit problematic is how exchanges will handle stock loan and cross-margining, meaning the ability to borrow a stock when youre making markets in options and to hedge positions with options and futures electronically. That concept, which advanced over many years in the U.S. market, does not exist in China, at least not at this moment.

OIC has entered into a content licensing agreement with The Shanghai Stock Exchange to create an educational program for financial professionals and investors in China, marking the first time a content licensing agreement for OIC has been executed with a financial institution in mainland China.

SSE will now be able to provide options education based on OIC’s content for financial professionals and investors, OIC said in a release. As China continues to expand access to various investment products, both OIC and SSE recognize the need to create an options education program to contribute to the development and responsible use of suitable financial products.

Last year OIC completed a “Train the Trainers” program with the Taipei Foundation of Finance. It was an intensive course in OIC teaching methods given to those who had a background in the financial markets. Those participants then had the necessary tools to teach options in mainland China.

“From what weve heard, it has been very successful,” said Grigoletto. “The Taipei Foundation of Finance has done several events in mainland China and is teaching them in their own native Mandarin dialect.”

Featured image via xy/Dollar Photo Club