CSOP Hikes Options Cap to 49% on SK Hynix 2x ETF Amid Swap Market Strain

A Hong Kong-listed ETF that tracks SK Hynix with 2x leverage has raised its limit for using options to 49% of its assets.

This change was necessary because extreme stock volatility and surging demand made it difficult and expensive to get leverage through traditional swap contracts with banks.

While this allows the ETF to maintain its 2x daily target, it also increases operating costs and the risk of the fund's performance deviating from its goal.

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A popular Hong Kong-based ETF designed to deliver twice the daily return of SK Hynix stock has adjusted its strategy to cope with market pressure.

CSOP Asset Management announced it is raising the limit on how much of its SK Hynix Daily (2x) Leveraged Product can be invested in options, from 40% to 49%. This move might seem technical, but it reveals significant stress in the financial system's plumbing, caused by the meteoric rise of SK Hynix's stock, which has surged over 330% this year.

So, why is this happening? First, this ETF primarily uses a financial tool called a 'total return swap' to achieve its 2x leverage. In simple terms, the ETF pays a fee to a bank, and in return, the bank provides the performance of the underlying asset, multiplied by two. It's an efficient way to get leveraged exposure without buying all the stock directly.

However, there's a problem. SK Hynix's stock has become so volatile and popular that the banks providing these swaps are getting nervous. The sheer scale of the ETF (over $5 billion) and the extreme daily price swings make it risky and expensive for banks to hedge their positions. As a result, they have dramatically increased the financing rates for these swaps—in some cases by over 1,000 basis points—and even started turning away new business. This is like a key supplier suddenly restricting supply and raising prices.

This brings us to the second point: the pivot to options. With swaps becoming scarce and costly, the ETF manager, CSOP, needs another way to maintain the 2x leverage. The next best tool is options. By buying call options, the fund can gain exposure to SK Hynix's upside. To do this, CSOP had to get regulatory approval to increase its options usage, first to 40% in May and now to 49%. While this is a necessary solution, options come with their own costs, which can increase the fund's expenses and lead to a larger 'tracking difference'—meaning the ETF's return might not perfectly match twice the stock's daily return.

In essence, the incredible success of SK Hynix stock has created a victim of its own success scenario for this leveraged product. The infrastructure supporting it is struggling to keep up, forcing the fund manager to use more expensive tools that could impact investor returns.

Glossary:
Leveraged ETF: A fund that uses financial derivatives and debt to amplify the returns of an underlying index or stock. A 2x ETF aims to return twice the daily performance of its benchmark.
Total Return Swap: A contract where one party agrees to pay the total return (income and capital gains) of an asset in exchange for a set fee from another party. It's a common way for ETFs to get synthetic exposure.
Tracking Difference: The gap between an ETF's performance and the performance of the index or asset it is designed to track. Higher costs or inefficient hedging can widen this gap.