the development of kospi 200 index futures in korea haitong securities conference research center...

The development of KOSPI 200 Index futures in Korea

Haitong Securities Conference

Research Center

Gyun Jun ( 全均 ) [email protected]

2007. 12. 07

Equity Derivatives Analyst

22

CONTENTS

33

44

11Derivatives market in Korea

Past & now of KOSPI200 index futures market

Market participants

Some issues

11

Derivatives Market in Korea

Exchange Traded Derivatives

OTC Derivatives

4Samsung SecuritiesSamsung Securities

三三星星證證券券

Equity Derivatives Market in KOREA

Year 2006

• KOSPI200 Futures Market = KRW 4,071 X 10 12 (KRW)• KOSPI200 Options Market = KRW 144 X 10 12 (KRW)

• KOSPI Stock Market = KRW 848 X 10 12 (KRW)• KOSPI Market Capitalization = KRW 704 X 10 12 (KRW)

• KOREA GDP = KRW 759 X 10 12 (KRW)

Derivatives Market Size in Korea (bil USD)

Source: FSS



KRX Products

Exchange Traded Derivatives

DateDate ProductsProducts Underlying assetUnderlying asset

1996. 5 KOSPI 200 Index Futures Stock Index

1997. 7 KOSPI 200 Index Options Stock Index

1999. 4

USD/KRW Futures Currency

USD/KRW Options Currency

Gold Futures Commodity

CD interest rate Futures Interest rate

1999. 9 3-year KTB Futures Interest rate

2001. 1 KOSDAQ 50 Index Futures Stock Index (delisted)

2001. 9 KOSPI 200 Futures spread Stock Index

2001. 12 KOSDAQ 50 Index Options Stock Index (delisted)

2002. 1 Single stock Options 30 single stocks

2002. 5 Options on 3-year KTB Futures Interest rate

2002. 12 MSB (Monetary Stabilization Bond) Futures Interest rate

2003. 8 5-year KTB Futures Interest rate

2005. 12 STAR Index Futures Stock Index

2006. 6EURO/KRW Futures Currency

JPY/KRW Futures Currency



Exquisite timing

History of KOSPI 200 Derivatives

Source : Samsung Securities

0.00

300.00

600.00

900.00

1,200.00

1,500.00

1,800.00

2,100.00

Jan-90 Jan-92 Jan-94 Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06

(pt)

KOSPI200 Futures

KOSPI200 Options

IMF

IT Bubble

KOSPI



OTC Products

Equity products

Index (Equity) swap Exotic Options – Basket, Digital, Barrier Equity Linked Securities (ELN) – Capital guaranteed, Yield enhanced Variance swap

Fixed Income products

Super spread notes (CMT)

TARN, Range accrual notes, IRS Currency products

Exotic options CRS

Market participants Securities firms (Local, Global IB) Bank, ITCs, Insurance Hedge fund



22

KOSPI200 Index Futures

Product specification

Market size & trend



KOSPI 200 Index futures in the world

• The 5th largest index futures market in the world : excluding mini futures, the 3rd index futures

• Leading group in emerging market : until 2004, the 1st index futures market in the Asia

Largest index futures in the world

Source: WFE



Spec

KOSPI 200 Futures Spec

Contract size KOSPI200 index * KRW 500,000 (1USD = 930 KRW, 537 USD)

Contract months Four consecutive near months from the Quarterly (3,6,9,12)

Tick size & Value 0.05pt, KRW 25,000

Last trading day Second Thursday on the contract month

Final settlement Cash

Daily price limit 10% of the previous closing price

Position limits Net position of 7,500 contracts

Circuit breakers +/- 5% of the previous closing price & +/-3% of the dispersion ratio

KOSPI 200 Futures Spread

Final settlement Cash

Contract months

3 contract months between the nearest month series and one of three other series

- The first spread: the nearest month series + the second nearest month series

- The second spread: the nearest month series + the third nearest month series

- The third spread: the nearest month series + the farthest month series



Trading Size

Average daily trading volume

-

50,000

100,000

150,000

200,000

250,000

300,000

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

(contracts)

Note: As of Oct 2007Source: KRX, Samsung Securities

• Until 2003, rapid growth of the trading volume: since 2004, trading volume has been stagnant.

• Entering the maturity phase: less volume, more efficiency



Trading Volume

• DLR (Derivatives Liquidity Ratio), average 330% in 2007: DLR = (Futures trading value / Cash trading value) * 100: Inverse trading indicator

• Early phase after market launched, DLR was lower than 1.0: do not hasty after launching.

DLR at the beginning stage of market

Source: FIA, Samsung securitiesNote: As of Oct 2007Source: KRX, Samsung Securities

DLR

0%

200%

400%

600%

800%

1000%

Jul-97 Jan-00 Jul-02 Jan-05 Jul-07

0

500

1000

1500

2000

2500(pt)

KOSPI(RTH)

DLR(LTH)

IMF 911



Efficiency in pricing

• Disparity = (Market price – Theoretical price) / Theoretical price * 100: indicator which can measure the efficiency of futures pricing

• Since 2004, no extreme disparity distribution: more efficient KOSPI200 futures market

Distribution of disparities, by year

Source: KRX, Samsung securities



Volatility shrinking

Historical Volatility of KOSPI 200

Note: based on GARCH model Source: KRX, Samsung Securities

0

10

20

30

40

50

60

70

80

Jan-90 Jan-92 Feb-94 Feb-96 Mar-98 Jun-00 Dec-02 May-05 Oct-07

(%)

IMF

K200Futures

• After the KOSPI 200 futures market launched, IMF crisis invaded: weak relation between the stock market volatility and the opening of futures market

• Since 2000, market volatility has been shrunk.



Change of stock market after launching futures market

• Asymmetric response of volatility to news

: Only stock market, - since shortage of short sale, over-sensitive response to negative information

: Stock & Futures market, - by capitalization the market information (both positive and negative), the asymmetry response of volatility to news can reduce.

• Transfer of Noise trader from cash market to futures market

: more rapid response to the market information for future market -> effect of leading / lagging : Leverage tools & Retail investor -> Existence of noise trader



Change of stock market after launching futures market

• Analysis of the stock volatility’s symmetry between pre 96 and post 96 (each 5 years)

• Mitigated the asymmetry of the stock volatility in post 1996

1996.5 ~ 2001.12

Source: KRX, Samsung securitiesSource: KRX, Samsung Securities

1990.1 ~ 1996.4



33

Change of Investors’ mix

Triangle of Investors group

Strategy of investors



Triangle of Investors group

Share of KOSPI200 futures market, by Investors group


0

20

40

60

80

100

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

(%)

Foreign

Retail

Securitie

ITCs

• Early phase: Securities (dealer) vs Retail (individual)

• Since 2003: Retail vs Foreigner vs Securities



Stock market & Other investors

Investor breakdown for stock market


0

1

2

3

4

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

(%)

Bank

Pension

Insurance

Merchant


Investor breakdown for KOSPI 200 futures market

0

20

40

60

80

100

2002 2003 2004 2005 2006 2007

(%)

Foreigner

Retail

ITCs

Securitie

• In stock market: retail overwhelming, foreigner vs ITCs

• Other investors in KOSPI200 futures market: only less than 5%



Restrictions on Foreign Investor

ID registration QFII system not employed limitation on the retention of open interests

Before May 1998

Open interest limit for foreign investor : total investment limit & per capita limit

Loosening the limit for foreign investor positive aspect : enhancing the liquidity of futures market negatives aspect ; indiscriminate inflow of foreign investors

Oct 96 Nov 96 May 97 June 97 July 97 Nov 97 Dec 97 May 98

Equity Individual 5% 5% 6% 6% 6% 7% 50% 100%

Aggregate 20% 20% 23% 23% 23% 26% 50% 100%

K200 Futures

Individual 3% 5% 5% 5% 5% 5% 5% 100%

Aggregate 15% 30% 30% 30% 100% 100% 100% 100%

K200 Options

Individual 5% 5% 5% 5% 100%

Aggregate 30% 100% 100% 100% 100%



Effect of Foreign Investor in KOSPI 200 Futures market

Foreign investors’ portion in stock market increased Tiger Fund in 1998 The IT bubble burst in 2000 and the Plastic bubble burst in 2002 Strategic portfolio rebalancing with KTB futures

Advanced financing techniques

Arbitrage trading Index swap hedging Options market making & Options-Futures multi trading

Market volatility to be boosted Large scale of futures trading when short-term momentum appeared (domestic investors following)



44

Some Issues

Program trading

Like hedge funds – Long / Short

Some lessons



Arbitrage Trading

ArbitrageCash – Futures Arbitrage : Market basisCash – Options ArbitrageFutures – Options Arbitrage

Cash convert ETF

KOSPI 200 FuturesKOSPI 200 Futures KOSPI 200 BasketKOSPI 200 Basket

ETFETF

Tax exempted

Synthetic FuturesSynthetic Futures

Dividend yieldDividend yieldFinancial costFinancial cost

Source: KRX, Samsung Securities



Extension of scale arbitrage inventory

Arbitrage

-

1,000

2,000

3,000

4,000

5,000

6,000

Jan-99 Jun-00 Nov-01 Apr-03 Sep-04 Feb-06 Jul-07

(KRW bil)

Csah- Futures Arb

Rev Cash- Futures

Since 2005, arbitrage trading has become more active & bigger.

Arbitrage trading players are ITCs, Pension Fund, Foreign Investors etc..

On every double witching day, the market has been more volatile than normal trading day.Because redemption & roll-over volume of arbitrage are dedicated at expiry day.




Like Hedge Funds

Long / Short Alpha creating possible with short index futures

KOSPI200 FuturesKOSPI200 FuturesBasket

(Value, Low beta ..)

Short Long

KOSPI200 FuturesKOSPI200 Futures Single Stock

KOSPI200 FuturesKOSPI200 Futures Nikkei 225 ..




Reconstitution of KOSPI 200

KOSPI 200 rebalancing

Once per year: the next day after final trading day of June contractsYear Changes

2003 29

2004 39

2005 11

2006 15

2007 11

New entries

exclusion

Buying pressureBuying pressure

Selling pressureSelling pressure

Long / ShortLong / Short




Program trading & Impact on stock market

(%)Samsung Elec. POSCO Hyundai Motors SK Telecom

Short Long Short Long Short Long Short Long

2004 4.52 4.55 8.22 8.60 13.96 12.89 13.88 14.65

2005 11.52 11.57 11.83 13.09 12.89 12.35 19.70 20.06

2006 16.54 19.66 14.27 16.33 11.37 12.59 18.55 20.89

2007 17.54 16.83 21.30 19.66 13.18 12.48 20.44 17.35


• Program trading accounts for more than 10% of total KOSPI market in 2007: In 2000, less than 3%

• Increasing impact on individual stock: Larger market cap, more exposure to program trading

• More volatile market, more exposure: By index cash – futures arbitrage trading: By basket trading



Basic of other derivatives

Hedging tools

Hedging of ELS (Equity linked Securities)

-> dynamic hedging by index futures

Hedging of Index swap

Hedging the positions of Index options

-> Market maker

Proxy for regional index

to hedge of other country’s stock market



Change of Investors’ mix

Imbalance of cash-futures market

Wag the dog effect Conservative Institutional investors are hindered

Domestic investors crowding out from futures market

Reduction of domestic institutional investors’ shares

Unfair trading by cash & futures connection

Large short position in futures market -> drawdown stock market -> bargain hunting the large caps -> short covering the short position in futures market



High liquidity in futures market

Virtue circle

High liquidity in futures market -> Inflows from foreign investors to stock & futures market -> Amplification of liquidity in the stock market

Contribution of developing other derivatives

Two face of coin -> a lot of dispute on the role of futures market



Driving Factors for success of Derivatives

1. Volatility – attractable products for hedgers & speculators

2. Money at risk – Market size, Capital flow both of domestic & Cross border

3. Participants – Institutional Investors’ asset, Producer & Distributor, Domestic & abroad

4. Liquidity – Amount of underlying asset cash flow, transaction cost

5. Diversification – to fulfill the various needs of investors

6. Confidence – of regulators, of market participants

Reference : George Tsetsekos, Panos Varangis, “Lessons in Structuring Derivatives Exchanges”, World bank, Feb 2000

Oliver Frartzscher, “Emerging Derivatives markets in Asia”, World bank, Mar 2006



May 2006

Services available at Samsung DerivativesSam

su

ng

S

ecu

rities

KOSPI 200 Index Futures & Options

Program Trading

Securities Lending and Borrowing (SLB) & Synthetic positions

Equity Linked Warrant (ELW)

And whatever you are interested in….



Compliance

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