March 15, 2019 / 9:31 AM / 2 months ago

China investors catch option fever, prompting regulator warnings

SHANGHAI (Reuters) - A rally that has made China’s stock market the world’s best-performing this year has fed a rush of leveraged bets in the country’s stock options market, prompting regulators to warn investors of rising risks.

FILE PHOTO: People look at an electronic board showing stock information at a brokerage house in Shanghai, China July 6, 2018. REUTERS/Aly Song

Growing interest in China’s equity option market came after a contract soared as much as 19,267 percent in a single session last month.

Data from the Shanghai Stock Exchange shows that the number of open contract positions in the ChinaAMC 50 ETF exceeded 3 million for the first time on record this week as investors hope to take advantage of the equity bull run to land huge profits.

An option gives investors the right to buy or sell the underlying asset at a set price on a specific date. The ChinaAMC 50 ETF tracks the SSE 50 index, dubbed China’s “nifty fifty index”, which has risen more than 20 percent this year.

Interest has been concentrated in a call option expiring March 27 that gives investors the right to buy the ETF at 3 yuan ($0.4467), in effect a bet that the ETF will jump at least an additional 9.5 percent this month from its closing price of 2.74 yuan on Friday.

If the ETF does not reach the option’s strike price of 3 yuan by the expiry date, the option will be rendered worthless.

Zhang Yi, an options analyst at Everbright Futures Co Ltd, said that a buoyant stock market has driven investor hopes of making a quick fortune.

“Some investors are jumping into the options market, without understanding the basics of this instrument, such as what the time value of an option is.”

The speculation has prompted a warning from the Shanghai Stock Exchange.

In a statement on March 8, the exchange noted large volumes, open positions, and price fluctuations on option contracts, and warned investors of the risk that the time value of the option would rapidly diminish ahead of its expiry.

The price of the 3 yuan call option expiring March 27 plunged more than 22 percent on Friday to 0.0052 yuan.

Despite the recent frenzy, Zhang said the words of caution from regulators and stringent risk-management rules in place mean that that there is little risk of a dangerous option bubble.

“China’s option market is still small, and has huge potential to grow, as there’s huge demand for this tool for risk-management,” he said.

(For a graphic on 'Option frenzy' click tmsnrt.rs/2O4LB4g)

Reporting by Andrew Galbraith and Samuel Shen; Editing by Kim Coghill

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