WHEN markets plunged in January, led by China, one index in Asia was hit more than most - a move that sent shudders through the region’s growing band of volatility traders, as the world braced for a re-run of the turmoil that overtook the market the previous September.

The index that volatility traders were watching most closely was the Hang Seng China Enterprises Index (HSCEI), made up of Hong Kong-listed mainland companies. In 2015, when China’s markets were soaring, it had become the reference point of choice for ‘autocallable securities’ in South Korea, a popular and risky retail product.

The worst fears of traders did not materialise as the global mood subsequently recovered. But this year’s wild market swings have awakened interest in Asia’s lack of a liquid tool that can help protect portfolios and trading positions held by banks and hedge funds from bouts of turmoil.

Wild swings have highlighted the lack of a Vix counterpart for the region’s investors

“In periods where we have volatility and uncertainty then asset managers and hedge funds are looking to take advantage of that,” says Shane Carroll, derivatives strategist at Société Générale, who adds that interest had been rising for several years.

Investors in the US can turn to the CBOE’s Vix, a gauge of implied S&P 500 volatility. Across US markets there is a range of participants, such as banks and credit investors, keen to limit risk to hedge funds focused on potential arbitrages, not to mention retail investors trading options.

Although Asian exchanges have created indices that seek to replicate the Wall Street equity model, including the V-Nikkei and the V-Hang Seng, the market in products based on them is illiquid, according to hedge funds.

That leaves banks as the key mediators, as holders of volatility risk, between the buyers of the structured products they have sold - huge markets in the likes of South Korea, Taiwan and Japan - and those hedge funds with an interest. As the banks selling the products to clients have effectively gone long implied volatility, they need a liquid market that can allow them to hedge that risk.

The limited number of volatility traders in the region and the scale of South Korea’s retail structured products market is such that ‘vol’ is normally cheaper in Asia. That helped autocallable sellers to hedge by attracting interest from hedge funds keen on the low prices offered on products such as variance swaps. These allow investors to place bets on future levels of volatility relative to current levels.

However, when the HSCEI began to plunge in the weeks following China’s surprise devaluation, the trades were structured such that the speed of the decline in effect wiped out the banks’ hedge by increasing their overall sensitivity to the sharp moves.

The result has been a shift to other products that seek to better match banks’ risks as well as a rise in the price of volatility in the region. Instruments called corridor variance swaps, which are active only when indices are in a certain range, are one such answer.

Investors are also expressing rising interest in dividend futures as a way of coping with market volatility that may not reflect, or even affect, the underlying economy. These exchange traded contracts are based on expected dividend payouts by a calendar date, allowing traders to hedge dividend exposure or place bets on whether or not a company will pay out.

For now, with markets in more buoyant mood, the volatility landscape has quietened down in Asia. Even the HSCEI is back above 9,000 after its lurch as low as 7,500 in February, although still short of the 10,000 rule of thumb used by bankers as a gauge of risk appetite deal.

But those in the market warn this is just the calm before the next storm.

“What we see for the coming year is that what is called the ‘vol of vol’, or ‘volatility of volatility’, will be very high,” says Govert Heijboer, co-chief investment officer at True Partner, who manages a specialist volatility fund.

“People should remember that when the 2007, 2008 crisis started happening we had an intermediate period when it was somewhat quiet before it all started again.”

Published in Dawn, Business & Finance weekly, April 25th, 2016