KWEB options arrive in Europe as ETF ecosystem grows

Eurex’s KWEB options, which reference KraneShares' KWEB UCITS ETF, are representative of these developments. The ETF tracks the CSI Overseas China Internet Index, covering China-based companies whose primary businesses are within the internet and internet-related sectors, and represents a highly targeted exposure to China’s internet platform economy. With e-commerce, social media, gaming, cloud computing, AI and online services companies all included as constituents, the ETF gives investors a unique exposure to China's digital ecosystem.

Meanwhile, Eurex is growing its status as a hub for managing thematic risk, as this style of investing continues to increase in popularity across the world. With options on KWEB, investors are gaining access to a capital-efficient and UCITS-compliant instrument for navigating that risk.

KWEB exposure also allows European investors to stay aligned with global demand trends for high volatility exposures. By partnering with KraneShares, which has already seen the successful growth of US-listed options on the KWEB ETF, Eurex has not only ensured an effective marketing strategy to capture that demand, but also maintained support for a robust liquidity build.

"Within Eurex we host a large number of derivatives and for ETF options it is always critical that there is support from the issuer as they typically have better intel than us on who owns their ETFs," says Zubin Ramdarshan, Global Co-Head of Derivatives Products and Markets at Eurex. "So, who the owners are and where they are based. That then gives us insights into the use cases, or the demand profile for the options. For us, the most important factor for listing this option was knowing we had that support from KraneShares."

Building Europe’s ETF options markets

The launch also reflects a broader structural opportunity within European markets. ETF adoption in Europe has grown significantly and currently stands at around USD 3 trillion in AUM, but still trails behind the US, where ETF AUM is closer to USD 13 trillion. The gap is even more pronounced in ETF options.

Eurex is well-positioned to make up ground here, with a robust ETF infrastructure already in place. This comprises strong existing relationships with fund clients, Clearstream integration and SimCorp connectivity. Parent company Deutsche Börse's portfolio also includes dedicated ETF listing venue, Xetra.

These foundations have already allowed Eurex to develop competitive commodity ETF and fixed income ETF offerings. There is ground to make up in equity ETF options however, on which front the KWEB ETF options mark significant progress.

The heart of China’s digital economy

Structurally, KWEB differs from broader China indices, which typically include financials, industrials and state-owned enterprises across both mainland and offshore listings. Its technology exposure is also distinct. Compared to global technology funds, KWEB is more reflective of platform companies integrating technologies such as artificial intelligence into consumer-facing applications, leading to different performance drivers tied more closely to Chinese consumer trends and regulation.

However, this does not mean the exposure is too complex for international investors to manage, as the ETF's constituents are companies listed offshore in the U.S. and Hong Kong. Performance is also driven by a relatively small number of firms with consumer-facing applications, creating more targeted exposure to Chinese consumer trends and regulation.

This comes through holdings in companies such as Tencent, Alibaba and PDD Holdings (owner of Temu) – firms often compared to U.S. technology giants in scale and influence.

With Eurex-listed options on the ETF, the appeal of the exposure has broadened further. Now, investors with less involvement or interest in China tech can also participate in trading the theme. This is a trend that has already played out in U.S.-listed options on KWEB.

"We have seen a lot of success and interest in options on KWEB in the U.S. over the last few years," says James Maund, Head of Capital Markets at KraneShares. "Just the implied vol and skew profile of KWEB alone, being a China tech exposure, allows for enhanced outcomes compared to what we see from a lot of the other U.S. and global indexes."

In a further sign of the European options launch's potential, US KWEB options have also been used in ETFs that create structured product-like features such as downside protection and upside capture. 

Then of course, there are the use cases of the options themselves on a standalone basis.

"When you have options you create a whole new series of outcomes," says Maund. "Primarily, those come through enhanced income, but with a variety of different options and strategies you can also obtain downside protection, potentially at low or no cost, depending on the volume skew profile at the time that you execute the trade. Those are the two most popular use cases for options on ETFs."

"This theme in particular is very volatile. China tech has a rapid rate of innovation, which is really exciting for investors. But there is so much innovation that what was the hot story today could fall by the wayside tomorrow in favour of something else. There is also the overlay of geopolitical scenarios to consider. It’s one thing to trade an ETF around that, but it's another to have a core ETF position and then modify what are essentially your insurance, or protection levels, around that, or potentially lever those positions up through options."

Building Liquidity and Market Structure

A liquid options market will be crucial to enhancing these benefits of going long China exposure, gaining protection and income generation. On the other side of the coin, liquidity in the underlying ETF is also essential for managing vega and gamma risk, with delta hedging the gamma especially dependent on a liquid underlying. 

In the early days of the Eurex market, the liquidity build is likely to be supported by market-makers and other liquidity providers in the US KWEB options. These market participants will assume some level of risk as they manage UCITS versus 1940 Act exposure. 

Over time though, liquidity in the Eurex options is set to develop in its own right. A foundation of this will be block trading infrastructure, given that institutional investors, who need to trade in size, will be the primary driving force in the first stages of the market’s growth. 

Block trading agreements are already in place at Eurex with three top-tier banks. That number is set to grow and market-makers who offer liquidity in both the KWEB ETF and its options are set to play an important role in educating new entrants on how best to optimize their trades. 

Constructive interest is already building from European pension funds, private banks and wealth management firms. Retail investors interested in exposure to the China tech theme are also a future source of liquidity, especially given their importance to advancing the success of the EU’s Savings and Investment Union.

"Each one of those investor bases has their own reason to use options," says Henry Reece, Business Development Director at KraneShares.

"There is also consistent demand from the retail space, the private banks and structured products that use options. So, every one of the broad investor pools that use the ETFs also has reason to use these options."