China Expected to Allow Trading of Index Futures

Speculation continues to grow that China could allow the trading of index futures as early as this Spring. Recent reports indicate that the China Securities Regulatory Commission has won approval to launch index futures, and it is expected that the first futures contract to be offered will be based on the CSI 300 Index – a compilation of three hundred stocks traded on the Shanghai and Shenzhen stock exchanges. The CSI 300 is weighted primarily with insurance and financial stocks, but also includes companies active in mining, energy, information technology, and the consumer goods sector.

An index futures contract – like any form of futures contract – is an agreement to buy or sell a product or service at a future date, and at an agreed upon price. The price for the futures contract is ¬derived by calculating a forward price based on the current value of the index, multiplied by a certain amount.

In the case of the CSI 300 index future contract, 300 yuan is the designated multiplier amount, and investors will be required to deposit 10 percent of the total contract value in order to buy or sell short, a CSI 300 futures contract. Using yesterday’s close of 3545.19 as an example, the total value of the contract would be 1,063,557 yuan (3545.19 X 300) – taking into account the 10 percent requirement, it would cost 106,356 yuan for an investor to buy or sell short a single contract.

Futures Trading

The ability to deal in futures contracts is seen as an important step in the evolution of trading in China. To date, investor’s wishing to deal in equities, could only buy stocks and could only profit when these stocks gained in price; however, with the ability to short index futures, investors will soon have the means to make profits in a declining market as well.

Investors are also expected to use futures contracts as a means to hedge open positions. Shorting an index futures contract that mirrors the individual long positions in an investor’s portfolio, helps to reduce the risk of losses in the equity positions should individual stock prices fall. This will likely be an extremely popular option for equity traders that have suffered through the notorious volatility experienced by China’s primary exchanges. In early August of 2009 for example, the CSI 300 index was trading at just under 3800 – by the end of August, however, it fell more than 25 percent to 2830 in just a few weeks! For the remainder of the year, the index continued to “whipsaw”, coming close to the August high on several occasions, but ultimately falling short, but still closing the year at nearly 3,600.

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