On July 6, PP, PVC and LLDPE options are officially launched on the Dalian Commodity Exchange (DCE), which marks the first time that three options in the same industry are launched simultaneously. On the first listing day, the three options operate steadily on the whole, demonstrating sound functions of price discovery and risk mitigation, when the options market and the futures market of the same underlying commodities recorded sound correlation. All stakeholders in the market are looking forward to the prospect of options being used to improve the risk management system for chemical products and serve the development of the chemical industry.
Rational trading on the first day
There are 10 options series launched for each of the three chemicals, with a total of 1,174 contracts. The largest options positions of PP, PVC, and LLDPE all fall under the 2009 options series of which trading volume account for 77%, 85%, and 79% of the total options trading volume of each chemical. The contracts with the largest call options positions are PP2009-C-7600, V2009-C-6300 in-the-money options and L2009-C-7400 out-of-the-money options. The contracts with the largest put options positions are PP2009-P-7500, V2009-P-6300, and L2009-P-7100, all of which are out-of-the-money options.
From the perspective of trading scale, the total trading volume of the three options on the first day is 22,766 lots (unilateral, the same below), the trading turnover is CNY 16.63 million, and the open interest is 14,409 lots. The trading volume of PP, PVC and LLDPE options are 11,043 lots, 2,545 lots and 9,178 lots respectively; and the open interests are 7,109 lots, 1,684 lots and 5,616 lots respectively. The trading volume of each options is about 2% of that of the underlying futures. In terms of implied volatility, after the market opening, the implied volatility of at-the-money options contracts for the dominant series of the three chemicals is around 20%. By the market close, there has been no significant volatility. “The limited range of implied volatility of options shows that the market gives a more neutral risk premium for futures price fluctuations, and the market performance is mature and rational,” Everbright Futures analyst Zhou Ao said.
Zhou Ao also noted that options and the underlying futures show strong correlation, and the price of the dominant options contracts is closely linked to the futures price. It can be seen from the trend of options prices that the market is more bullish about plastic chemical products. The trend of futures prices can also reflect this mood. The prices of dominant contracts of PP, PVC and LLDPE options trended upward throughout the day.
Lu Rui, an energy industry researcher of the Commodity Department of Luzheng Futures, believes that since now is the peak time for the overhaul of polyolefin equipment by the upstream producers, plus the delay in the arrival of imported commodities to designated ports, the short-term supply has decreased month-on-month. Demand of the chemical products by downstream factories remains stable, and traders expect that the peak demand season is about to come, therefore pushing up the total demand.
According to people with insights into the industry, PP and PE are very likely to face supply/demand imbalance in the short term. As prices become more volatile, companies can take advantage of the nascent options market around the two commodities. “For companies that hold spot goods, if they believe that the market has a high probability of assuming an upward trend, but are still concerned that the possible price drop will cause the inventory to depreciate, they can try to buy at-the-money put options to have more flexibility in hedging against the risk,” Zhou Ao suggested.
Active participation of industrial enterprises to seize opportunities
The PP, PVC and LLDPE futures are very well-established in the market, leading to many options market participants and active trading after the launching of the three options. The active participation of industrial clients is a testament to the good liquidity of the market. “With more futures products being added to the domestic derivatives market, especially the launching of chemical product futures and options, the derivatives available in China can now cover the entire supply chain of the chemical industry, featuring the important trend of integrated development of both industries and financial sector.” Shao Shiping, Assistant General Manager of Zhejiang Mingri Holdings Group, said that it’s precisely because of these advantages that Zhejiang Mingri chooses to enter the market in the first stage after these options are launched so as to make the first move.
According to her, Zhejiang Mingri mainly traded on 2009-P-7600 contract of PP on July 6. “Judging from the fundamentals of the PP market, the price remains volatile within a certain range, but the market is generally at a discount, so we decide to sell call options to enhance the gains of our spot inventory.”
In fact, with the risk management of the industrial supply chain getting more and more complex, hedging with futures alone is unable to meet diversified business needs. Therefore, there is an urgent need for innovative tools for risk management and hedging. “As a service provider for the polyolefin industry, our main business model is options-based trade, and the share of such business is growing in size. The risk accumulated in the process is also increasing. We need derivatives such as floor-traded options to hedge against the risk,” Shao Shiping said.
Talking about the feeling of trading in the market on the first day, Shao Shiping believes that the price of the shallow out-of-the-money options of the dominant contract is very close to the market, and the overall price is slightly lower than that of OTC options. “Because the floor-traded options adopt a centralized offering and matching system, the price information is open and transparent, which is more attractive to traders who believe it means good value for participation.” In her view, the floor-traded options have smaller volatility and are recognized by different market participants. Therefore, the price is fairer as buyers and sellers are both fully engaged in the market.
It’s learned that Zhejiang Topchance Petro-Chemical Co., Ltd., which is in the middle of the industrial supply chain, participates in the trading of PVC and LLDPE options contract 2009. “When the market is bullish, we can close some short positions in the futures market and buy in the put options for the purpose of hedging. In doing so, we can ease the pressure of a margin call in case of a floating loss in the futures market, while hedging against falling prices. If the price continues to rise, we can still benefit from spot inventory.” Song Shiwei, deputy manager of the company’s financial investment department, said that the bid-ask spread on the first-day market was relatively good, and the market-maker’s response was also fast. When we traded with an order size of 20~30 lots per deal, it can basically be executed at the middle price.
In his view, with the popularization of options, there will be more and more industrial clients and investors participating in the market. “Especially for large industrial enterprises, there is usually demand for hedging against medium and long-term risk. At a time when it’s increasingly difficult to predict the trend of price, enterprises can use options to hedge against risks according to their actual situation, while at the same time keeping positions in the favorable direction. Such practice will greatly improve the efficiency of corporate risk management,” Song Shiwei added.
In this regard, Shao Shiping also believes that options are characterized by asymmetric returns, and are particularly suitable for industrial enterprises to conduct hedge trading in reference to their own spot positions. “Since options is still a nascent tool in China, I hope that more efforts can be made to inform and train enterprises on how to harness options as a tool to better manage risks. In this way, the participation of industrial enterprises in the options market will also increase significantly.”
In the view of Wang Lin, the research director of China-Base Petrochemical Co., Ltd., with the increasing participation of enterprises along the industrial supply chain in the options market, the market will become more active and liquid. “With the solid debut of the three major chemical options, I believe that more chemical enterprises will adopt the options tools and promote options-based trade in the market, truly applying the options-based strategy to spot trading,” he said.
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