Hong Kong Offers Asia’s First Volatility Index Futures as Swap Alternative

Hong Kong’s stock market today started selling the first futures tracking volatility in Asia, the fastest-growing region for derivatives.

Futures (VHSH2) on the HSI Volatility Index (VHSI), which tracks expected equity-market volatility over the next 30 days, are the first of their kind based on an Asian market, according to Calvin Tai, head of trading at the Hong Kong Exchanges & Clearing Ltd. The Osaka Securities Exchange Co. will begin offering futures on Japan’s Nikkei Stock Average Volatility Index (VNKY) on Feb. 27, according to the bourse.

Volatility index futures have been trading in the U.S. since 2004 and Europe since 2005. The products were created as alternatives to so-called variance swaps, derivatives in which investors take a position on how much a stock or index will move with a bank or dealer instead of via a public exchange. The futures surged in popularity after the 2008 financial crisis, when investors sought products that allowed them to hedge against large market swings.

“It’s definitely something that’s been missing from the product suite in Asia,” Shane Miller, head of flow index trading for the Asia Pacific region at Barclays Capital. “For the more professional investors, who would normally trade variance swaps, this gives them another way to invest in volatility. This product will allow less sophisticated investors holding portfolios of cash or stocks to implement a hedge they didn’t previously have access to.”

Institutional Investors

Ten trades comprised of fifteen contracts, each worth HK$5,000 passed across the exchange on the first day, according to data compiled by Bloomberg. All were February futures contracts, closing at HK$24.50.

“It takes a certain amount of time for people to get comfortable with the product and comfortable with the risk,” Miller said. “Most clients today were focused on the broader macro factors. I think that’s where the focus was, and expect them to have more interest in the coming weeks.”

The HSI Volatility Index was created by Hang Seng Indexes Co. and calculated by the Chicago Board Options Exchange and Standard & Poor’s. It began trading on Feb. 21 last year. The Hong Kong gauge rose 5 percent to 23.84 at the close, indicating investors expect a 6.8 percent swing in the Hang Seng Index in the next 30 days.

“We think institutional investors would come into this market first,” Tai said in a telephone interview on Feb. 17. “We have educational and promotional plans later this year. We are going to work with brokers, and exchange participants to conduct a few rounds of simulation trading on this product.”

Product Evolution

Exchange-traded notes, exchange-traded funds and other structured products have been created in the U.S. and Europe around volatility futures. Similar products may be reproduced in Asia if demand is sufficient, Tai and Miller said in separate interviews.

Volatility index futures products “received attention after the collapse of Lehman Brothers Holdings Inc. (LEHMQ)” in 2008, Osaka Securities Exchange Co. spokesman Masahiro Yada told Bloomberg News. “As global events continued, like the Greece debt crisis and U.S. debt downgrade, financial institutions saw the need to protect their investments and there was more demand for the product.”

To contact the reporters on this story: Eleni Himaras in Hong Kong at ehimaras@bloomberg.net; Kana Nishizawa in Hong Kong at knishizawa5@bloomberg.net

To contact the editor responsible for this story: Nick Gentle at ngentle2@bloomberg.net

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