Overhauling derivatives market

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Overhauling derivatives market

Volatility in a market is unavoidable. But steep volatility governed by a group of speculative forces is hazardous, as it undermines market credibility and leaves lasting damage on investors.

Speculation is not itself a crime. It is just a negative term for profit-seeking and price arbitration. But speculative forces tend to push prices to levels that allow them to reap huge profits at the cost of majority.

Korea’s trade volume in derivative financial instruments in the first half of the year was the world’s largest, taking up 16 percent of global trade. Meanwhile, the Seoul equity market accounted for a modest 2 percent of the global capitalization turnover. The derivatives market has enlarged to abnormal levels.

Local regulations have also fanned abnormal expansion. The settlement procedure is unreasonable because the settlement price used for options on the Kospi index is determined by the weighted average price of all component stocks in the last 30 minutes of trading on the day that they mature. Other foreign markets usually weight the average prices of the last three days.

The local options market is also an easy environment for risky “scalping.” Scalping, a technique that buys instruments when a stock declines and sells on rallies, works best in a volatile market. It is the temptation that attracts investors all over the market, making it the world’s largest in trade volume. The Korean Stock Exchange just sits idly in the backseat, happy with the fat commissions it reaps from volatile futures and options prices and heavy trading.

The Financial Services Commission said it will revise the deposit system of private funds after the options market plunged two weeks ago. But it is a limited fix, designed to protect hedge funds more than investors and the market.

The local derivatives market has turned into a playground for global hedge funds. They employ the smartest mathematicians to come up with riskier bets and are now looking beyond futures to attempt a foray into the foreign exchange and debt market. The derivatives market will eventually shake the underlying financial market. The composite stock price index see-sawed by more than 2 percent 44 times out of the 159 days that futures and options have matured on the same day since 1997.

It is time to consider quality over quantity in the derivatives market. Authorities should revise hazardous rules, impose a tax on the futures and options trade, and strengthen its review and oversight of over-the-counter instruments.
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