Korea Capital Market Institute, Lee Hyo Seob Discuss for “Individual Investors and Market Efficiency in KOSPI 200 index option Market” Korea Capital Market Institute, Lee Hyo Seob (2014.8.21, 10th APAD conference)

Summary Results 1. Number of Trades by individuals has decreased from 22,742 to 13,945 (▽38.6%). Share of individuals slightly decreased from 97.1% to 95.7%. 2. Daily Trading amount has also decreased 1.68(tr won) to 1.18 (▽30%). 3. Individuals suffer a big loss even after the regulation. The ratio of foreign investors decrease over time. The risk-adjustment performance of individuals is still poor. 4. Individual Investors sell OTM & DOTM more than buy. It’s difficult to say individual investors are risk lovers. 5. The proportion of market & aggressive limit orders are high for individuals. Since fleeting orders are high for foreigners, they are likely to be market makers. 6. Both individuals & institutions trade by momentum. They buy more calls & sell more puts after positive KOSPI 200 index returns 7. Individuals’ herding measure is greater than that of institutions & foreigners. 8. Individuals are not informed investors. Foreigners buy options at low implied volatility, but individuals do reversely. 9. The huge loss of individuals does not result from trading DOTM options. They make profits from trading DITM options. 10. Foreigners have dominant power in explaining the variance of efficient price.

Implications for Empirical Findings Regulation of increasing option multiplier is not effective. It only decreases trading amount and shortens the profit ratio of foreigners. The reason why individuals have a big loss might be attributed to their trading habits such as herding behavior. They are momentum traders to the return & the volatility. Another reason why individuals have a big loss might be attributed to the macro information asymmetry. Foreigners are more informed traders. Therefore, policy makers should try to change the individuals’ herding and to decrease the information asymmetry between individuals & others. Then, how to persuade policy makers for sound growth of ETD market? Unfortunately, they announce that qualified individuals who get an 80 hour’s education and enough open-account margin with 30/50 million won can access ETD market.

Let policy makers know the side effect of regulation As regulation arbitrages are higher, advantages of derivatives such as financial innovation, RM, making complete market are getting lower. The risk-lovers who have to be protected in Korea shall go overseas market which might be not protected for individual protection. De-regulation with perfect competition and lowest information asymmetry is the most rigid and desirable regulation. Trend of trading number of ETD Outbound derivatives’ volume Source: KOFIA Source: KOFIA

Make the ETD market for professional traders Inducing more domestic institutions to participate in Korea ETD market. Recently, the ratio of domestic institutions has sharply decreased by 20%, 10% in KOSPI 200 futures & options market. Try to induce NPS to use KOSPI 200 futures & options for the purpose of hedging arbitrage program trading. Deregulate the rules about derivatives management. Risk amount ratio of derivatives should not be in excess of AUM, DOTM for NCR. Introduce incentive compatible market micro-structures such as market-markers and block trading for domestic institutions. Investor types of KOSPI 200 futures Investor types of KOSPI 200 options Source: KRX Source: KRX

Keep an effort for individual investors protection Competitive exchanges(ex: HKEx) keep an effort to educate individual traders about the risk of leverage products, and try to provide more products for retail individual investors. Recently, TASS database shows that the ratio of individual investors grows by 25% in the equity & equity index derivatives. Try to control a systematic risk even in ETD market. After Hanmag trading error event, controlling risk of algorithm trading & settlement becomes more important. Derivatives trading volume by investor types Source: HKEx

Thank you very much.