Korea becomes king of derivatives hill [FT]
By Anna Fifield
Published: January 3 2006 19:23 | Last updated: January 3 2006 19:23
South Korea’s strengthening economy, a soaring stock market and a population increasingly keen on new investment products have coincided to make it the world’s busiest market for equity derivatives.
Only a few years after stock index derivative products were introduced to Asia’s fourth largest economy, Korea has overtaken the US to record the highest turnover volumes globally, on the back of a stock market that repeatedly hit all-time highs last year.
“While the world has been focusing on the strong growth in China and India, 2005 has turned out to be the year of Korea,” says Andy Xie, chief Asia-Pacific economist at Morgan Stanley.
“Its stock market and currency have been the best performing in Asia. Its economy appears to be transitioning successfully from ‘developing’ to ‘developed’ – a change that, outside the west, only Japan has achieved to date,” he writes in a research report.
Korea’s benchmark Kospi share price index rose by over 50 per cent in 2005, while the Korean won appreciated by another 10 per cent against the dollar on top of 2004’s double-digit gains.
The Bank of International Settlements notes that within this boom, Korean stock index futures and options trading has exploded – turnover increased by 71 per cent to $12,000bn in the third quarter of 2005.
Even when stripping out the impact of the sharp rise in the Kospi 200 index, turnover growth remained “impressive” at more than 50 per cent, the central banks’ bank writes in its latest quarterly review.
The BIS notes that trading in Korea was heavily geared towards options, which accounted for 93 per cent of trading volumes in the third quarter, compared with just under half in the US market. Meanwhile, open interest in Korean stock index contracts at the end of September amounted to a “mere” $64bn, whereas that in US contracts stood more than 50 times higher at $3,300bn.
“Both the predominance of options and the low level of open interest are related to a third characteristic that sets the Korean derivatives market apart from those in other countries,” writes Christian Upper of the BIS. “Individual investors account for approximately two-thirds of trading in options and one-half of trading in futures on the Kospi 200, far higher than in other markets.”
Local analysts note the gusto with which Koreans have taken to trading.
“Korean people have a very ‘quickly quickly’ approach, and individual investors want to make a quick win from their investment,” says Jeon Woo-jong at South Korea Securities. “The derivatives market is so volatile and fluctuations are much more severe compared with the stock market, so there are plenty of trading opportunities.”
Korea’s advanced IT infrastructure – it is the most wired country on earth, with three-quarters of homes having broadband access – and home trading systems have also helped foster this retail boom, Mr Jeon says.
After a few rocky years in the Korean markets, individual investors are looking at more sophisticated and creative investment products, which the government is encouraging in its drive to broaden the capital markets.
But the major factor leading Koreans to the markets are the low returns on bank deposits. Although the Bank of Korea raised its benchmark interest rate twice since October, it remains low at 3.75 per cent.
Ross Gregory, an equity derivatives structurer in the Korean office of Macquarie, the Australian investment bank, says that equity-linked securities have been providing annualised returns of 8-16 per cent, with early pay-outs on good performers.
“People are taking a more aggressive approach to investing and are looking at these highly liquid instruments,” Mr Gregory says.
But the sudden strong performance of the derivatives markets is prompting concern that a bubble may be forming. However, sentiment remains upbeat. Lee Seon-kyu, a director at Woori Securities in Seoul, says: “Everyone is winning, so unless someone starts to lose, I think this bullishness will continue [in 2006].”
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