Managing Risk in China’s Volatile Markets
There’s no denying that China’s capital markets are undergoing rapid change. Just in February of this year, the SSE 50 Index exchange-traded fund (ETF) was introduced as the first stock index option in China. As a result, investors can now buy and sell options on an ETF that tracks the 50 largest yuan-denominated stocks in the Shanghai Stock Exchange (SSE). This move was intended to help minimize investor risk by allowing individuals a means of quickly exiting failing stocks and giving them options to be used as tools for hedging investments.
As background, Chinese ETFs are composed of China-based companies that may be listed in the U.S., Hong Kong or Shanghai stock exchanges. Investors are often attracted to Chinese ETF’s because they offer exposure to the world’s largest population and the second-largest and one of the fastest growing economies. However, while most financial participants had high expectations for the SSE 50 ETF upon its introduction into the marketplace, thus far trading volume has been low. This disappointing performance can largely be attributed to stringent restrictions put into place by the China Securities Regulatory Commission (CSRC), which have made it less desirable to trade the option. However, the promising news is that currently the Chinese market is beginning to open up, so projections on ETF 50 are expected to improve. Additionally, it’s likely that the CSRC will allow further options products to be traded in China in the near future. Moreover, many Chinese securities and futures firms have already or are in the process of establishing their OTC operations now.
While trading Chinese options does offer financial institutions great opportunity, the ever-changing nature of this market also introduces substantial risk. To properly cope and ultimately remain profitable, firms will need to evaluate the type of infrastructure they are using to mitigate risk. The right solution can help Chinese derivatives dealers gain stability in an otherwise volatile capital markets environment.
Specifically, firms should look for a solution that provides a fast, accurate, flexible, transparent, and holistic solution for valuation and risk management of multi-asset, multi-currency derivative portfolios. This will enable firms to easily add new instruments without needing to write code, a task which can become extremely time-intensive for busy quants. There are solutions in the market today, such as FINCAD’s F3 Platform, that fit this bill nicely. FINCAD’s F3 technology provides robust pricing and risk management capabilities including key risk sensitivities for vanilla and complex trades or portfolios, enabling firms trading Chinese options to make optimal investment and risk management decisions.
Managing portfolio risk is one area that derivatives firms often struggle with particularly in light of regulatory pressures such as those introduced by Basel III. But firms utilizing powerful risk analytics can enhance governance by easily accessing risk sensitivities to all market data points and hedging required notionals (i.e., the sensitivity information necessary for effective hedging and risk measurement). This is accomplished in FINCAD’s F3 Platform using our patented Universal Algorithmic Differentiation™ (UAD) method, which calculates risk sensitivities or Greeks in a fraction of the time it takes using traditional curve bumping methods. UAD enables firms to manage exposure on a pre-trade basis, rather than an overnight one, helping them not only with regulatory compliance, but also with greater certainty in their trading.
Another element of UAD that may be particularly useful for firms trading in the Chinese markets is the technique’s universal coverage for a range of instruments. This helps firms take advantage of new opportunities as they are introduced to the marketplace, all while safely managing their exposure.
For more information on how to reduce risk and sustain profitability in the Chinese capital markets, please read our eBook: The Case for Algorithmic Differentiation