Chinese Snowball Derivatives Meet Hell

August 2021: China regulators step up risk control over popular Snowball derivatives - sources

China's securities watchdog has tightened scrutiny on a popular derivative product dubbed Snowball, three sources told Reuters, as regulators seek to rein in risks in an opaque, $60 billion market.

Snowball, which offers a risky bet on stock market volatility and delivers double-digit, annualised returns barring a market tumble, has gained popularity among yield-hungry investors.

Pennies in front of the steamroller: selling volatility.

"Snowball products are often marketed as a type of fixed-income products, and investors are not fully aware of the risks. This worries regulators," a source said.

Here we go.

Some rival products offer annualised returns of as high as 20%. The benchmark Shanghai Composite Index SSEC. has gained 1.49% so far this year.

"You make money in a volatile market. You make money in a bullish market. But if you buy the product at the start of a bear market, you lose," Wang Yichao, managing director of Guotai Yuanxin Asset Management Co, told a roadshow on Snowball on Thursday.

About that: not quite a bear yet, down 15-percent from the recent high to the recent low. Do you want to bet on that trendline holding though?

This article in iFeng says snowball products are being blamed for recent market weakness: 雪球“背锅”市场大跌？业内：一切销售正常，不宜妖魔化！真相如何？

"Recently, the sales of Snowball products are normal. The index snowball at the retail end has not been knocked-in in a concentrated manner. There is still a lot of room for the knock-in line. The possibility of the index falling sharply at this position is relatively low, so we I think the overall risk is still controllable." A person from the innovative finance department of a large securities firm in Shanghai told a Chinese reporter from a brokerage firm.

Another brokerage sales person said that there is no special response from customers to Snowball products at present, and the company is also continuing to issue Snowball products.

"I have heard some unfriendly remarks, but those are all speculations of people in the non-derivatives industry. In fact, derivatives play a role in calming fluctuations in the market." said a derivatives person at a brokerage.

"Because the snowballs that open at the high point are basically 12 to 24 months in duration, the probability that the index will not rebound for such a long time in the future is very small, so as long as customers have a certain amount of patience, they can also get the set price at the beginning of the period. Profitable. Of course, I personally think that this kind of knock-in situation is basically difficult to occur, and it is an extremely unlikely event." The above-mentioned person explained.

A market source said that it is not appropriate to over-beautify snowball products, but it is also not appropriate to demonize them. Snowball structure products have certain risks, which mainly depend on the accuracy of investors' prediction of the market. According to him, there are two main types of risks in snowball structure products: one is the risk of knock-in caused by falling market prices, that is, the risk of principal loss; After the Snowball product was knocked out in advance, it was difficult to find the risk of assets with higher yields.

Another article: 雪球产品被传“爆炸”，是否该为市场急跌“背锅”？

2. Has the index plummeted snowballed "because of the blame"?

An asset manager of a brokerage firm in East China said that the reason cannot be attributed to a certain type of product, the scale of derivatives will not be very large, and the impact of snowball on the market will not be so great.

Yu Mingming, chief of the gold working group of Cinda Securities and deputy general manager of the research institute, pointed out in previous research that Snowball is not a beast. Acting on the convergence of the stock index futures discount rate will not have a significant impact on the direction of the index.

Mr. Jia, who is engaged in market work in the financial leasing industry, often comes into contact with options in his work, and has also been concerned about Xueqiu products for a long time. He analyzed that: "Look at Xueqiu's contract and know that if you type in, the product will be a fixed income product. It has become a futures index product that rises and falls with the index.”

In his understanding, the knock-in means that the over-the-counter put option has been exercised, and the product itself has no leverage.

Specifically, it is inevitable that the most important Greek letter of Snowball products - Delta.

According to Yu Mingming's analysis, Delta is the change between the product price and the underlying price. For ordinary vanilla options, the delta range is between [-1, 1], but exotic options no longer follow this principle. The figure below shows the Delta of the snowball structure. Distribution chart, in which the horizontal axis is the percentage of the underlying price, and the vertical axis is the delta value. As can be seen from the figure, when the underlying price is near the knock-in boundary of 0.85, the delta is the largest, about 1.6, and as the underlying price rises, the delta Rapid decline, when the underlying price exceeds the knockout boundary of 1.03, the Delta tends to 0, and the price of the snowball is no longer sensitive to the underlying price.

Maybe the "snowball derivatives" won't all melt to zero in a bear market. Or maybe they will, but won't cause major knock on damage. At the very least however, they show the type of reckless risk-taking that is found at speculative tops. My bet is that trendline on the Shanghai Composite won't hold.