Derivatives investment strategy 30 Apr, 2015
Measures to vitalize derivatives
market released
Derivatives
Plans to advance Korean derivatives market released

Last week, on April 23, the Financial Services Commission (FSC) announced measures to
stimulate the derivatives market. The three most important measures are the introduction of: 1)
mini index products; 2) products to support spot markets; and 3) a new fee structure for options
transactions.

Key details include the launch of mini-futures and mini-options, KOSDAQ Single Stock Equity
Futures, and RMB Futures.
Further improvements needed

However, it is disappointing that the measures have yet to address the lofty entrance barrier for
individual investors and the transfer tax levied on derivatives transactions.

Even for mini-products, the initial margin required is W30mn~W50mn, a hurdle most individual
investors will find difficult to overcome.
Mini-futures and options markets to grow fast

As seen in the cases of E-Mini S&P 500 Futures and E-Mini NASDAQ 100 Futures, mini
products ate into existing markets, reducing their transaction volumes. We expect to see a
similar phenomenon in Korea.

In Japan and Hong Kong, both existing and mini markets grew together.
Derivatives investment strategy
Measures to vitalize derivatives market announced
On Apr 23, the FSC announced measures to vitalize the derivatives market as part of its capital
market reform plan. Out of a total of 15 measures, the FSC identified action to stimulate the
derivatives market as a quick and easy target. We need to note that these measures are a little
different from the ones announced in June last year in terms of the policy approach.
The three key measures impacting the derivatives market will be the introduction of: 1) mini index
products; 2) products to support spot markets; and 3) a reasonable fee structure for options
transactions.
The FSC plans to introduce Mini KOSPI 200 Futures and Options, whose contracts will be only
one fifth the size of their existing counterparts. As of Apr 28, 2015, one KOSPI 200 Futures
contract was worth more than W130mn (268.55pts x W0.5bn = W134.28mn), while the mini
product would cost only W26mn (268.55pts x W0.1mn= W26.86mn). Similarly, as of Apr 28, one
KOSPI 200 Options contract cost W30mn, while the mini product would cost W6m.
As for new products to support spot markets, the FSC will introduce KOSDAQ Single Stock
Futures and New Dividend Index Futures, whose underlying asset is the New Dividend Index
announced by the KRX in Oct 2014. In addition, RMB Futures will be introduced to help those
engaged in RMB-based settlement and direct RMB transactions to manage forex risk.
Efforts to rationalize the options fee structure in Korea will affect the current scheme where fees
are charged in proportion to transaction value. Base fees and fee caps will be established for
KOSPI 200 Index options and mini options, dollar options, and equity options so that large-value
transactions benefit from economies of scale (and vice versa for small-value transactions).
Derivatives market vitalization measures (summary)
Measures
Detailed plan
Introduction of mini index products
Introduce mini KOSPI 200 Futures and Options
1) Introduce KOSDAQ Single Stock Futures
Introduction of new products to support spot markets
2) Introduce Dividend Index Futures
Rationalization of options transaction fee structure
Establish base fee and fee cap
3) Introduce RMB Futures
Source: Financial Services Commission, Yuanta Securities
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Derivatives investment strategy
Disappointing in some respects
Basically, we view the measures to facilitate the derivatives market as positive, but we do not
believe they are innovative enough. For example, after the authorities announced tighter
regulations and taxes on derivatives products in 2014 (10% capital gains tax on KOSPI 200
Futures and Options from Jan 1, 2016), no critical deregulations were announced this time. A
leading example of such regulations is the high entry barrier to the derivatives market.
Investors have to provide W30.0mn in initial margin for futures and W50.0mn for options, although
for new mini products the per-contract price will be lower. For example, according to the
announced plan, one Mini KOSPI 200 Futures contract would amount to W26.0mn (based on Apr
28, 2015, contract prices) and its 15% margin would be W3.9mn. However, investors need to
basically provide W30.0mn in initial margin (the amount used for trading is W3.9mn, but investors
become eligible for futures trading only after they deposit at least W30.0mn).
Moreover, the 10% capital gains tax introduced in 2014 does not allow investors who do
spot/futures arbitrage trading or trade futures to hedge against share price declines to offset
futures gains/losses against equity gains/losses.
Thus, the introduction of new products will not be enough to facilitate trading in Korea’s entire
derivatives market. In particular, investors who left Korea’s index futures/options markets over the
past two~three years mostly moved to spot and futures markets in neighboring countries. The
introduction of new products is welcome news, but accessibility to those products does not differ
from that of current products.
We believe new derivatives instruments will not be enough to recover the Korean derivatives
market’s global competitiveness and reinvigorate the capital market. However, RMB Futures and
other plans related to spot products were announced, which would enable risk management and
price discovery, improving the diversity of the derivatives market.
Schedule to introduce new derivatives products
New product/measure
When
Mini KOSPI 200 Futures and Options
July
KOSDAQ Single Stock Futures
July
Dividend Index Futures
August
RMB Futures
September
Set base fee and fee cap
Around July
Source: Financial Services Commission, Yuanta Securities
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Derivatives investment strategy
Review of E-mini S&P 500 Futures and E-mini NASDAQ 100 Futures in US
We traced changes in the market in the wake of the E-mini S&P 500 Futures and Nasdaq 100
Futures, albeit just for two years. The Chicago Mercantile Exchange (CME) introduced E-mini S&P
500 Futures on Sep 9, 1997 and E-mini Nasdaq 100 Futures on Jun 21, 1999. At that time, as
original futures were traded on both electronic and floor markets, mini futures were sure to
facilitate the markets.
Indeed, as the chart below shows, trading volume of E-Mini S&P 500 Futures rose sharply for the
first two years of its launch, while trading volume of existing S&P 500 Futures stagnated or
declined slightly. According to the KRX’s research, trading volume (original + mini) increased 2.4
times for US S&P 500 Futures, and 9.6 times for Japan’s Nikkei 225 Futures, and 2 times for Hong
Kong’s Hang Seng Futures five years after mini futures were introduced in their respective markets.
At the same time, for the 10 years since mini futures were introduced, annual trading volume
growth of original and mini futures was 3% vs 46% for Japan’s Nikkei 225 Futures and 15% vs
53% for Hong Kong’s Hang Seng Futures, respectively. As Japan and Hong Kong’s futures
markets were not big around the time of mini futures launches, both the original and mini futures
markets expanded. But in the US, where original S&P 500 Futures were traded actively, the
trading volume of the original S&P Futures declined, while that of E-mini S&P Futures increased.
Given the number of individual investors in Korea’s derivatives market and sharp fall in trading
volume of KOSPI 200 Index Futures and Options, the introduction of mini futures and options will
likely boost futures and options trading volume and improve investor access to the market
(assuming that there is no initial margin and no 10% tax on capital gains).
Trading volume before and after introduction of E-mini S&P 500 Futures in the US
('000 contracts)
S&P 500 Futures
250
('000 contracts)
E-mini S&P 500 Futures
120
E-mini S&P 500 Futures begin to trade
100
200
80
150
60
100
40
50
0
Sep-95
20
0
Mar-96
Source: Yuanta Securities
4
Sep-96
Mar-97
Sep-97
Mar-98
Sep-98
Mar-99
Derivatives investment strategy
Trading volume before and after introduction of E-mini Nasdaq 100 Futures in the US
('000 contracts)
Nasdaq 100 Futures
350
E-mini Nasdaq 100 Futures
E-mini Nasdaq 100 begin to trade
300
250
200
150
100
50
0
Jun-97
Dec-97
Jun-98
Dec-98
Jun-99
Dec-99
Jun-00
Dec-00
Source: Yuanta Securities
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Derivatives investment strategy
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Stock and sector ratings
 Stock ratings include an Investment Rating (Strong Buy, Buy, Hold, Sell) based on the expected absolute return of a stock over
the next 6 -12 months.
 - Strong Buy: Expected to return 30% or more
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Derivatives investment strategy
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