Accumulator activity boosted by increase in implied volatility

More than HK$1 billion ($129 million) of accumulator products was traded on June 3 in Hong Kong, the largest single-day volume for more than 18 months, dealers say.

In an accumulator, the buyer of the product agrees to acquire a fixed number of shares on each trading day over the life of the product, which would typically be six months to a year, so long as a knock-out event does not occur - usually defined as the stock price closing at or above a specified barrier, for instance 105% of its initial level. Crucially, the buyer acquires the stock at a discount to the initial spot price, for example 95% of the spot. However, if the spot were to drop below 95%, the investor is still obligated to buy shares at 95%, even though the shares are trading below that level.

Volumes have been increasing steadily since the end of March, in line with the equity market rally, and have also been helped by periods of sustained increases in implied volatility. This reverses the trend of declining issuance of accumulator trades that came in the wake of tanking Asian equity markets last year, which burned many private banking investors and even sparked a raft of lawsuits.

The equity market recovery in the second quarter has proved a catalyst for renewed demand. Hong Kong's Hang Seng Index (HSI) rallied more than 60% since hitting a low of 11,344.5 on March 9 to close at 18,253.39 on June 8.

Conditions for trades further improved during late May and early June as implied volatility rose. Implied volatility on the HSI was 35.83%, while the index traded at 18,389 on June 2, only for both indicators to rise to 37.2% and 18,680 respectively on June 5, according to the Royal Bank of Scotland (RBS). The positive momentum created the conditions for opportunistic trades.

"Typically, when the equity market falls, volatility rises, and vice versa," says Shane Edwards, Hong Kong-based global head of equity derivatives pricing and structuring at RBS. "But volatility rallied as Asian equity markets continued a forceful climb over recent weeks. This meant accumulators were being offered at very attractive levels. If an investor were to buy an accumulator trade they would effectively be selling volatility. Products that are short vega (vega is the sensitivity of the price of an option to a change in volatility) being priced in an environment with elevated volatility inevitably offer better terms. Hence the large volumes being traded."

The products have been traded predominantly on local banks and oil companies: popular names include the Industrial and Commercial Bank of China and PetroChina. MC.