Manufacturers of structured products in China are facing a challenging pricing environment with a 10% increase in the price of options as a result of high discount levels in the onshore index futures market caused by fall of the Chinese stockmarket.
In July, the three most commonly used onshore index futures recorded large discounts compared with the CSI 300 index with CSI 300 futures showing a 200bp discount, SSE 50 futures showing more than a 100bp discount and CSI 500 futures showing more than a 500bp discount.
The current discount on CSI 300 futures has increased the price of options for bearish products, according to Yang Lv, senior associate at CITIC Securities, one of the leading structured products manufacturers in China.
“The current discount situation has made call options cheaper but it is making it more difficult for us to hedge put options as we need to sacrifice the yield to cover the gap of the price discount between the index and the index futures,” said Lv, “In just one week, the price of the option has risen by 10% for put options and the cost will go higher if the situation persists.”
This situation, said Lv, is also having an impact on providers’ strategies as they are being forced to spend more on options and lower the capital invested in fixed-income assets. “To maintain the same level of return for investors, providers will have to issue partially protected products,” said Lv, adding that providers haven’t stopped issuing bearish products. “Distributors need to roll out products according to market needs and currently the demand for bearish products remains strong.”
Xiaoyun Lin, options Strategist at Xinhu Futures, said that while A-shares gradually recover from the recent drop in the stockmarket, A-shares index futures prices have been lower than the benchmark price because of the pessimistic market environment, but this doesn’t mean that the indices themselves will also follow a bearish trend.
“Normally a large-scale discount spread on index futures will attract institutional investors to conduct arbitrage trading and, in the end, alter the price of index future to be flat,” said Lin.
According to SRP's database, there were 29 products linked to the CSI 300 index added in July, a 6% decrease compared with the previous month’s issuance. Among them, Agricultural Bank of China and China Merchants Bank have launched 15 products with no capital protection.
Related stories:
A-share ETFs underperform Chinese market
Chinese ETF options gain traction after A-shares collapse