Magazine issues » July 2021

Inside view: The micro-derivatives revolution

Tzu-hsin_WuTzu-hsin Wu, chairman of the Taiwan Futures Exchange, breaks down “the new normal” in the derivatives trading landscape. In January 2021, investors around the world were abuzz not only about the Covid-19 pandemic and the promising results of vaccine trials, but also GameStop – an American video game retailer that rarely appears on the radar of investors. Retail investors, connecting together and organising on online message boards such as Reddit, effected a short squeeze that resulted in a 1,500% increase in the company’s stock price over the course of two weeks. As other acts of coordinated retail investing sent the share price of other companies surging, the phenomenon soon earned the moniker of ‘meme stock investing’. This somewhat disparaging label is inadequate in describing what is, effectively, a revolution – a retail trading revolution. Even before the pandemic, the expansion of low-fee and easy-to-use online brokers had greatly reduced entry barriers for smaller investors. But it really came into its own in 2020 when retail trading around the world skyrocketed as remote and furloughed workers took to dabbling in stock investing while under lockdown, driving global stock prices to new highs towards the end of the year. What has been less reported is the spillover of retail activity into derivatives markets. Pushed by retail trading, 587.9 million contracts of single stock options were traded in the US in March 2021, the highest monthly volume on record, more than doubling in the space of a year (from 287.7 million contracts in March 2020), according to the Options Clearing Corporation’s statistics. In Asia, trading volumes also rose in several retail-oriented derivatives markets such as India, South Korea and Taiwan. For example, the total number of trades made on the Taiwan Futures Exchange (Taifex) surged 30.9% in 2020 to hit an all-time high. It is heartening to see this level of activity on futures exchanges, given the crucial role derivatives plays in risk management and price discovery. It is essential that appropriate derivatives products are not only available, but also accessible to market participants of all sizes. While the GameStop short squeeze will be best remembered as the coming-out party for coordinated retail investing, the head-spinning price swings in the days that followed were a stark reminder to investors – both professional and amateur – that all investments carry risk, which can suddenly emerge from surprising places. Here to stay
Since then, retail investors have shown no signs of leaving, even when facing higher levels of volatility. Their increasing willingness to trade narrower and more specialised products – the sizes of which typically put them only in the reach of professional traders – suggest that they are a force that is here to stay. All members of the trading community, including fund managers, must adapt. There is already evidence of this. Around the world, new ‘micro-derivatives’ are being introduced as futures exchanges respond swiftly – to take advantage of both the new growth opportunities arising from greater participation by small investors and as part of their responsibility to keep markets accessible. For example, Nasdaq, CBOE and Eurex have recently listed Mini OMXS30 Futures, Mini-Russell 2000 Options, and micro futures based on the DAX and EURO STOXX 50, respectively, while CME Group is considering launching more micro options on index futures. In addition to the equity index space, similar developments are being seen elsewhere – the US–based Small Exchange has rolled out Small Treasury Yield futures and the Moscow Exchange has expanded its product suite to include mini-sized energy derivatives. Small contracts are equally flourishing in Asia. Thailand Futures Exchange added a rubber futures with one-fifth of the size of the contract referenced in Japan. Taifex recently launched a broader suite of mini single stock futures focusing on tech stocks, such as Taiwan Semiconductor Manufacturing Co Ltd. Taifex will soon go even further with the launch of Mini Electronics Sector Futures (see Figure 1) in late June 2021 as a proactive response to the surging stock prices of Taiwan-listed technology companies. These are crucial parts of the supply chain for the island’s cutting-edge semiconductor industry – a sector that is booming, driven by a global supply shortage. The contract value of standard Taifex’s Electronics Sector Index Futures has doubled compared to its launch, raising the entry barrier for many investors; the reduced size of the mini contract will facilitate a wider range of trading strategies, provide greater flexibility and enable further diversified portfolio allocations. With markets around the world set to become more volatile as new and unforeseen risks start to emerge beyond the pandemic, institutional investors – not just retail investors – can benefit from the micro-derivatives revolution and the rapidly evolving market structure; a market where there is more advanced and active trading by both retail and institutional investors. Welcome to the new normal in the derivatives trading landscape. © 2021 funds global asia

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