Leveraged ETFs Fueling Market Volatility Demand Regulatory Action

South Korea's stock market is experiencing unprecedented volatility, largely driven by the recent surge in trading of 2x leveraged Exchange Traded Funds (ETFs) focused on individual stocks, particularly semiconductor giants Samsung Electronics and SK Hynix. Since their launch in late May, these high-risk products have dramatically amplified market swings and raised concerns among regulators and investors.

Within a short period from May 27 to July 3, the trading volume for these single-stock leveraged ETFs reached a staggering 269.7 trillion won. This figure represented 19.5% of the total KOSPI market trading volume during the same timeframe, indicating a significant concentration of trading activity. The impact has been palpable, with the KOSPI market triggering the "side car" mechanism, a trading halt designed to curb excessive price fluctuations, 31 times this year. Notably, 13 of these instances occurred after the launch of these leveraged ETFs, averaging almost every other trading day.

The Bank of Korea has also voiced concerns, warning that the increased trading in these leveraged products could exacerbate the existing market concentration. Samsung Electronics and SK Hynix together constitute over 55% of the KOSPI's market capitalization and 64% of its trading volume, highlighting a significant skew in market influence. The volatility index (VKOSPI), often referred to as the "fear index," has also seen a sharp rise from an average of 53 before the ETFs' launch to 81 afterward.

These leveraged ETFs carry inherent risks, including the "negative compounding effect," where price fluctuations can lead to greater losses over time compared to the underlying asset's performance. For instance, SK Hynix experienced a -2.5% return from May 27 to July 2, while its corresponding leveraged ETF saw a -23.3% loss. Financial authorities are now under pressure to implement measures to protect investors, enhance education on the products' complex structures and risks, regulate aggressive marketing by brokerages, and potentially limit the issuance of new leveraged ETFs to restore market stability.

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With the market capitalization and trading volume of Samsung Electronics and SK Hynix expanding significantly to account for more than half of the stock market, the increased investment in single-stock leveraged ETFs is likely to intensify this concentration.