Exchanges

Volatility becomes an asset for HKEx

Hong Kong Exchanges and Clearing (HKEx) rolled out VHSI Futures, the first tradable volatility futures in Asia, on 20 February. Based on the VHSI (Volatility Hang Seng Index) that was launched this time last year, HKEx hopes the futures will help drive volumes on its derivatives-heavy market by allowing hedging of exposure to volatility risk. The product tracks expected equity-market volatility over the coming 30 days.

“Now we have an effective and efficient tool to help unload the volatility risk, that should increase the appetite to take on more trading of options-related products, so that would help develop those markets,” said Calvin Tai, head of trading at HKEx. “This product, with transparency on an exchange-traded platform, will also help by making pricing more efficient.”

Tai told theTRADEnews.com that HKEx has a very deep options-related business in Hong Kong – not just on the exchange but also in the OTC market. And it plans to leverage that depth.

With index options for derivatives, index-based warrants in the cash market, as well as a lot of OTC activity in index-linked notes, equity-linked notes and similar products, “We have a lot of people holding assets that are facing volatility risk,” said Tai. “So we built an index which is a benchmark to reflect the volatility movements in the Hong Kong markets.”

The idea is to have a benchmark for the market so participants who have volatility risk exposure can use this as a very direct, simple and low-cost tool for risk transfer.

As volatility has been fluctuating significantly in recent years, the minds of market participants around the globe have been more focused on its risks.

“Since the beginning of this year, it’s been pretty stable so far. In Hong Kong, the volatility is at around 23 to 4. Last year, the range was something like 20 to 50, but going back to the Lehman bankruptcy, it was as high as 80 to 100,” said Tai.

He explained that a lot of products in HKEx’s market are options-based, which means many participants sit on a portfolio of options and face volatility risk every day. “They have their own ways of hedging the delta but for the volatility risk, it’s more complicated for them to handle,” said Tai.

The futures methodology is based on the VIX model from CBOE (the Chicago Board Options Exchange), with some local customisation on some of the parameters. HKEx has brought three market makers on board to provide liquidity for the new product: BNP Paribas Securities, Goldman Sachs Futures and Newedge Financial Hong Kong.

According to Tai, the initial roll-out has been operationally smooth. He said the exchange had received “very encouraging feedback from institutional investors who are facing volatility risk through their options portfolios.”

Asset managers have been starting to look for types of asset classes which are not highly correlated to stock market performance, insisted Tai, no doubt partly in response to a tough 2011 on the Hang Seng. “They are now viewing volatility futures as such an asset class,” he added.

HKEx has been organising meetings and providing seminars for institutional investors about the new product, which Tai believes will “require a lot of education of the market”.

For individual investors, HKEx has been involved in organising a series of trading simulation sessions beginning in April, to provide hands-on experience of using VHSI Futures.

“It will take time for people to become comfortable with the product and go through a few rounds of settlement before institutional investors start using it in a big way,” said Tai.

Although Hong Kong has landed the title of ‘first in Asia’ with tradable volatility futures, other territories aren’t far behind. The Osaka Securities Exchange – traditionally Japan’s strongest derivatives bourse – is due to launch its own futures offering on the Nikkei Stock Average Volatility Index by the end of this month.

Gavin Blair