MSCI's Big China Decision Looms Today

Will the result offer opportunities in the options space?

[Editor’s notes: 1) China has now been included in MSCI's Emerging Markets Index. 2) The following originally appeared on cboe.com. Matt Moran is CBOE's vice president of business development.]

For managers of global index portfolios this week, a big issue is whether or not MSCI will add China A-Shares to the MSCI Emerging Markets Index (MXEF). MSCI plans to announce its 2017 Market Classification Review on Tuesday, June 20, shortly after 4:30 p.m. ET.

A June 17 headline to a Barron’s story speculated …

“Will China Gain Entry to MSCI Indexes? The giant indexer has said no three years in a row, but this time may be different. Approval would offer a nice boost to China’s capital levels.”

And a June 15 headline for a story in the Financial Times noted …

“Defining moment for investors looms as MSCI rules on China. Index provider set to make call on including mainland A-shares in its EM benchmark.”

The MSCI Emerging Markets Index

The MSCI Emerging Markets Index captures large- and midcap representation across 23 emerging market (EM) countries. As of May 31, the index had a total aggregate market capitalization of more than $4 trillion and 830 constituent stocks.

Recent Price Performance

The MSCI Emerging Markets Index has performed well so far in 2017. As shown in the chart below, from January 6 through June 16, the total return (pretax with reinvested dividends) version of the MSCI Emerging Markets Index rose 15%, higher than some other well-known indexes.

Volatility Since 2011

Emerging markets have had a reputation for being relatively volatile. Since June 2011, the CBOE VXEEM Index (the CBOE Emerging Markets ETF Volatility Index) has closed above 50 on 17 different dates (see charts directly below), while the highest daily closing value for the CBOE Volatility Index^® (VIX^®, an index that measures the expected volatility of the S&P 500^® Index) was only 48.00.

Compare the two volatility charts and note that the implied volatility often has been higher than historic volatility; at times options sellers might be able to take advantage of richly priced premiums.

Managing Global Equity Exposure With MXEF Options

CBOE offers options on the MSCI Emerging Markets Index (MXEF). Key features of the MXEF global index options include:

• Efficiency with large contract size – Cash-settled options on the MSCI indexes have a $100 multiplier and a notional size that is about 26 times larger than the options on the EFA and EEM ETFs.
• Simplicity – Achieve broad-market exposure in one trade, as options on MSCI options offer investors tools with the potential to adjust exposure to the global markets at a fraction of the cost of buying individual stocks and ETFs.
• Cash settlement – With no unwanted delivery of stocks or ETFs.
• Predetermined risk for option buyers – Index option purchasers risk only the premium they pay for the option. The risk is both known and limited.
• European-style exercise – Protects option sellers against assignment prior to expiration (so-called early assignment).

Volatility Skew For AMZN & MXEF Options

For investors who are exploring possible use of MXEF options, a key consideration is the volatility skew. Note that in the next chart, the Bloomberg estimates: 1) at-the-money 30-day implied volatility is 20.9 for Amazon (AMZN) options but only 13 for MXEF options; and 2)  options at 80% moneyness (could be applied to out-of-the-money protective put options) are 33 for MXEF options and 35.2 for AMZN options.

The slope of the volatility skew chart was more extreme for MXEF options, and this could have an impact on some options-buying and options-selling strategies.

Open Interest For Large-Sized MXEF Options

Open interest for both calls and puts on the MXEF Index has risen in recent months.

This article was originally published at cboe.com. For more information on managing global risk and on MXEF options, please visit www.cboe.com/MXEF. (Daniel Romero contributed research to this blog.)