Hang Seng Index Futures Open Interest and its Relationship with the Cash Market

Taking large open positions in the Hang Seng Index (HSI) futures formed part of the strategy of speculators in the 1998 episode of "speculative attacks" on the Hong Kong dollar and stock markets. The open interest in the HSI futures market has risen in the past three years, at one point to a record high level in the latter part of 2004. This note considers whether this should be a concern, and how such information can be assessed. Given the complexity of the futures market, it is difficult to construct a structural model to explain the level of open interest. Instead, this note attempts to extract useful information from available financial statistics, which may help shed light on the issue. This is achieved by examining the relevant statistical content of data on open interest and the historical relationship between open interest and other financial variables. Specifically, open interest is found to exhibit an upward trend since early 2002. It has a long run positive relationship with turnover in the cash market and the feedback between these two variables seems to run in both directions. On the other hand, no clear statistical relationship between the open interest and the short selling turnover, the price volatility in cash market, and the HSI level can be identified. Two "adjusted" open interest indicators ¡V the detrended open interest position and the ratio of open interest to cash market turnover ¡V are developed to facilitate assessing market conditions. In particular, these two indicators were found to be high in the last four months of 2004, but not as alarming as the raw data of open interest would suggest. These indicators will be monitored on a regular basis. Nevertheless, in view of the lack of a structural model, the role of market intelligence in assessing market developments remains critical.