CHINA’S first stock options will be launched next month with limited access to investors due to their risky nature, but their gradual rollout may benefit the real market.

    Investors wanting to use options to hedge or speculate will likely build up their holdings in index heavyweight stocks, which regulators have long wanted to develop.

    The China Securities Regulatory Commission (CSRC) will allow investors to trade only options that track the SSE50 index of the 50 biggest firms on the Shanghai Stock Exchange in the trial that begins Feb. 9.

    An option is a contract to buy or sell a stock at a predetermined price at a predetermined time in the future. The Shanghai bourse further laid out strict rules, under which individual investors can trade options, relying on rarely-used progressive qualification requirements.

    “Options are seen as a double-edged sword,” said Chen Huiqin, senior stock analyst at Huatai Securities in Nanjing.

    “So they will be developed slowly over a long period of time through an experiment in ETFs [exchange-traded funds] before individual stocks are involved, as regulators ‘feel for stones as they cross the river,’” Chen said, citing a famous saying by late Chinese leader Deng Xiaoping.

    Brokerages and futures companies trading financial derivatives will be the main beneficiaries of the options market, as they have the qualifications.

    Meanwhile, investors will likely raise holdings of SSE50 heavyweights such as top oil producer, PetroChina Co., and the biggest lender, Industrial and Commercial Bank of China.

    Regulators are essentially guiding investors into blue chips, which retail investors have avoided in favor of smaller firms. This has pushed up the valuation of smaller companies.

    Components in the SSE50 index have average price-to-earnings ratio of 10 times, compared with 17 times for the broader market.

    Options will allow investors to hedge their investments but may also expose speculators to heavy losses.

    The Shanghai exchange requires individual investors to hold at least 500,000 yuan (US$80,445) in cash and shares in a single trading account in order to trade options.

    Fewer than 5 percent of China’s roughly 50 million active stock trading accounts meet the standard as small retail investors account for 80 percent of stock trading by value.

    Participants then face three progressive exams: Those who pass the first test may use options to hedge their existing holdings, those who pass the second test can take long positions via options and only those who have passed the most difficult test can carry out comprehensive trading, including shorting.

    The tests will involve knowledge of securities markets, in particular about hedging tools including options, and will involve simulated trading, among other things. The bourse will also set a daily limit of 10 percent in either direction for both put and call options, the rules say.

    Traders point out that other Chinese derivatives have also been developed slowly as officials prefer a gradualist approach.

    The China Financial Futures Exchange, established in 2006 exclusively for the development of financial derivatives, did not launch its first product, stock index futures, until 2010.

    It only launched a second product, government bond futures, in 2013. But more than a year into trading, they are off limits to banks who most need futures to hedge interest rate risks as the authorities remain wary about lenders’ safety nets.

    “For a period of time, say one or two years, options may only be a gesture to show that the government is determined to continue market reforms, instead of a real product,” said a trader at a major domestic brokerage. (SD-Agencies)