Chip mania is heating up again! After leveraged ETFs were restricted, South Korean retail investors have turned their attention to even riskier CFDs.

South Korean individual investors are known for their high risk preference, and they are now flocking into a leverage tool that has caused massive losses in the past. With the stock market volatility intensifying, concerns about the sudden closure of these positions are also increasing. These products are known as Contracts-for-Difference (CFDs), which have been banned in the United States for retail investors, but South Korea still allows investors with sufficient account balance to trade. Investors do not need to actually hold the underlying asset, but can gain exposure to the market through CFDs. According to data from the Korea Financial Investment Association, as of this Monday, the size of CFD products in the country has increased by nearly two-thirds in the past year, reaching approximately 33 trillion Korean won (about $22 billion). The attractiveness of CFD lies in its leverage effect - investors only need to deposit 40% of the position value as margin to obtain full market exposure. However, the return of this tool comes at a sensitive time for the market. Previously, CFDs had caused market turmoil in 2023 and were subsequently strictly restricted. Currently, leveraged ETFs linked to chip manufacturers have significantly increased market volatility, even prompting regulatory agencies to halt the listing of single-stock leveraged ETFs. "The overall increase in system-wide leverage levels will inevitably increase risk," said Natasha Sibley, Portfolio Manager of the Janus Henderson Multi-Alternative Investment Team, "If other investors holding Korean chip stocks through CFDs or margin buying are forced to liquidate, stock prices are bound to be under pressure, thereby amplifying price fluctuations." The impact mechanism of CFD on the market is similar to leveraged ETFs: the counterparty to investors' trades - usually banks - needs to manage their own risk exposure through hedging, commonly by holding the underlying stocks. This means that when a client's CFD position is forcibly closed, the bank will sell the underlying asset accordingly, exacerbating market trends, similar to the impact of rebalancing operations by leverage ETFs. The difference is that the rebalancing of leveraged ETFs occurs daily, while the forced selling triggered by CFD occurs when additional margin is required. Maxence Visseau, Chief Investment Officer of Arkevium Capital, a hedge fund based in Dubai, pointed out that this makes the market impact of CFDs "more concentrated and more severe," with precedents already in place. In 2023, several natural gas stocks in South Korea consecutively hit the limit down due to additional margin calls triggered by CFD positions, touching the daily limit for several consecutive days. At the time, over 96% of participants in CFD trading were retail investors. The subsequent selling wave led to strict regulatory actions, causing the size of CFD positions to temporarily drop to historical lows. CFD was also one of the leverage tools used by Bill Hwang's Archegos Capital Management in the 2021 blow-up event. At the time, several banks forcibly closed its positions, resulting in the sale of billions of dollars worth of investments and ultimately leading to the fund's collapse. "We have seen this scene before," Visseau said, "CFD trading exists in its own off-exchange liquidity pool, and when that pool has to sell to the public market all at once, it does not bring about orderly adjustments but a sharp cliff." In the United States, CFDs are prohibited from being offered to non-professional investors. However, in South Korea, investors who have had an average monthly balance of over 300 million Korean won in stocks or derivatives for one year within the past five years are eligible to participate in CFD trading. The recent uptrend in the market has further fueled the popularity of this product. According to data from the Korea Financial Investment Association, as of July 20, long positions in Kospi index CFDs were nearing historical peaks. Looking at the fund flows of individual stocks, CFD positions in the past year have closely followed the market's star assets: SK Hynix CFD positions have surged nearly 2500%, reaching 235 billion Korean won; Samsung Electronics CFD positions have increased fivefold, reaching 217 billion Korean won. Currently, this derivative has even extended to leveraged ETFs related to these stocks. Although the size of the CFD market in South Korea is still relatively small compared to the overall stock market (about $39 trillion), investors and analysts are warning of potential risks as financing balances reached a high point last month. "If leveraged positions are concentrated in the same direction and cannot meet margin requirements, forced liquidation may be initiated, further exacerbating market volatility," said Lee HyoSeob, Director of the Financial Services Department at the Korea Capital Market Institute.