Will China Find Its Footing in the Options Market?

It's time to give a warm, options-world welcome to the newest member of the options community … hello, China! This, from Bloomberg:

"Contracts on the China 50 ETF, an exchange-traded fund tracking some of the country's biggest companies, began changing hands on the Shanghai Stock Exchange as part of a trial that Haitong Futures Co. predicts will eventually expand to options on equity indexes and single stocks. It's the first new equity derivative allowed by Chinese regulators since the 2010 introduction of index futures, a market that has grown about 10-fold in the past four years."

Now, it's not for everyone just yet. According to reports, you need an account of at least 500,000 yuan to get started (about $80,000). That won't matter all that much at first, as they are also limiting investors to position limits of 50 contracts. So what could possibly go wrong?

In theory, it's tough to manipulate a market with such tiny limits. But I'm guessing someone with the mind to do so could simply open a bunch of accounts and use the presumably small and wide markets to his advantage. Who's standing in the way of massive moves in implied volatility? It's tough to find a baseline when there's nothing else trading just yet.

You can use Hong Kong. But how's that going to correlate? You'd think pretty highly, but again, where's the mechanism to get them in line? It sounds like they've designed this slow rollout to avoid repeating a sordid history of manipulated derivatives markets. But I'm guessing that could work the other way, too.

We're not immune to any of this, of course. Ever see the opening options board in the S&P 500 Index (SPX) on a CBOE Volatility Index (VIX) settlement morning? But it just seems like all these low -- and somewhat artificial -- limits they're putting on here make it almost impossible for the market to absorb much of anything. I think I'd sooner roll out more products and higher limits from the get-go and let water seek its level. Small players shouldn't jump into products right away, anyway.

But alas, China stopped asking for my opinion on derivatives rollouts. It shouldn't change anything for us here. The iShares China Large-Cap ETF (FXI) is a deep and liquid exchange-traded fund and option, and it's a close enough proxy.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.