Index futures not for faint-hearted
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Chinese stock market punters are no doubt overjoyed to see index futures and other derivative products added to their box of investment tools, but riskier avenues heighten the perils of losing money as well as making it.
China will launch stock index futures on April 16, two weeks after the Shanghai and Shenzhen exchanges initiated pilot projects for margin trading and short selling for a handful of brokerages. The introduction of derivative products is part of the nation's measured reforms aimed at creating modern, multi-tiered markets similar to those overseas.
It seems natural for investors to want to pile more of their funds into stocks, after equity exchanges surged 80 percent last year and while deposit rates at banks trail inflation.
But with more new products on offer, the stock market becomes a more complicated playground for mom and pop investors anxious to get better rates of return on their money. It's not a game for the faint-hearted.
Index futures are cash-settled contracts to buy or sell an index at a preset value on an agreed date. In other words, you can bet on the direction of equity indexes. If you think they will rise, you buy contracts. If you think they will fall, you sell contracts. Index futures are often used as hedging tools, allowing an investor to cover potential losses.
It works like this. If you have a portfolio of shares and you are worried that their value will drop in coming months, you take out an index futures contract betting that the index will drop. If it does, the money you gain by having bet correctly offsets the lower value of underlying shares. It's a cheaper insurance policy than selling a whole portfolio of shares, given brokerage fees.
It all sounds so simple and foolproof, but those who think derivatives trading is a piece of cake had better think twice. After all, it was sophisticated derivative products that traders didn't fully understand that triggered the global financial meltdown.
More than 80 percent of investors who participated in a virtual program trading stock index futures ended up losing money, according to Chinese media reports.
"I don't think this is something that ordinary domestic stock investors should play with," said Zhu Yuchen, general manager of China Financial Futures Exchange, where the stock index futures will be traded. "This is purely for professional investors, and that's why some restrictions are needed."
Indeed, individual investors will be required to have a minimum of 500,000 yuan (US$73,250) to open a derivatives-trading account. They will also have to participate in mock trading lessons for at least 10 sessions.
The minimum trading account requirement is well beyond the means of many retail investors, especially with banks under government orders to rein in lending.
Restricted trading
The rules are all aimed at maintaining the stability of China's capital markets and reminding investors that the new tool is not as simple as ordinary share trading. Some analysts are worried that index futures may become a new tool for so-called "hot money" speculators.
The restrictions on who may trade index futures may bar many retail investors from participating directly in the new program, but there are indirect ways to benefit.
The index futures will be based on the underlying 300 shares of the CSI 300 index, composed of the biggest blue chips on the Shanghai and Shenzhen stock exchanges. Margin trading and short selling cover the top 50 Shanghai-listed firms by market value and the top 40 Shenzhen-listed firms.
That means the new trading tools will focus attention on the biggest blue chips in China.
"The launch of stock index futures, margin trading and short-selling will usher more capital into low-valuation blue chips," said Liu Zhiyan, an analyst at Fortune Securities Co.
Indeed, after China Financial Futures Exchange announced the launch for index futures, the Shanghai Composite Index rebounded for three straight days, led by blue chips.
Investors can also invest in the shares of big brokerages such as Haitong Securities Co and Citic Securities Co, which are among the six trading houses officially designated to participate in the pilot programs for margin trading and stock short selling. Haitong Securities shares rose 2 percent since the trial program began.
Mom and pop investors need to do their homework before plunging into any aspect of the expanding trading realm.
"Retail investors typically go for short-term speculation in derivatives markets, which enlarges the trading risk, so index futures aren't really suitable for inexperienced investors," said Jin Yanshi, an analyst at Sinolink Securities Co.
"But retail investors can indirectly deal in stock indexes by investing in a fund," Jin added. "They can set a leverage ratio with the fund in advance to control the risks."
For those with larger sums of capital, a private equity fund that manages money flexibly and invests in index futures to seek a higher return may be an ideal investment vehicle.
On a longer term basis, index futures and margin trading are just the starting bells for China's market reforms. Premier Wen Jiabao has called for more efforts to boost direct financing, develop a multi-tier capital market and expand the size of equity and securities financing to meet diversified demands.
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