What are snowball derivatives, and what happens when they melt?
They are essentially a bet that a stock index will trade within a prescribed range; but the way they behave when markets rally suggests that they may not deliver the expected returns
INVESTORS in China are piling back into a risky category of derivatives known as snowballs, potentially frustrating financial regulators who tried to rein in the products last year when they exacerbated a stock-market slump.
Snowballs have been modified since then, making them a little safer than earlier iterations. Their potential returns are drawing in many wealthier savers frustrated by the low yields currently offered by less-volatile investments such as bonds. Some are hoping to recoup wealth that evaporated in a years-long real estate market slump.
But the way snowballs behave when stock markets rally – and China’s benchmark CSI 300 Index jumped 10 per cent in August, its best performance since September 2024 – suggests that they may not deliver the kind of returns that investors have come to expect.
What are snowballs?
Snowballs are derivatives sold in China that are tied to the performance of an underlying stock index. They offer to pay investors coupons similar to those on a bond as long as that index stays within a predetermined range.
If the index rises above the top of the range, then a so-called “knock-out” is triggered, in which the contract terminates and investors receive the coupon for the period to date. If the index drops below the bottom of the range, then a “knock-in” occurs, in which they receive no coupon and potentially lose part of their capital.
In the space of just a few years, snowballs have become a popular offering from the nation’s largest financial brokers, including Citic Securities Co and China International Capital Corp (CICC).
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What are the risks associated with investing in snowball derivatives?
The snowballs offered by Chinese brokers typically offer potential annualised returns of between 12 and 20 per cent. They are most frequently linked to the two most popular small-cap indexes: the CSI 500 or CSI 1000. The name “snowball” came about as a reference to the potential accumulation of gains for investors who hold them – rather than the risk that their investments could melt away.
Snowballs are frequently marketed as fixed-income-style products because of the set coupons they pay on a regular basis, unless the underlying index moves outside its designated range. The brokerages that sell these contracts acquire futures contracts tied to the same index as a way to hedge their bets and earn an income. This can accelerate a decline in the stock market as the brokers will rush to close those positions when the knock-in levels are reached, putting further selling pressure on stocks.
Stock-trading in China is dominated by retail investors, who are more likely than institutional investors to panic and sell out fast when there is a market downturn. That makes it more risky to bet that indexes will trade within a range until snowballs mature, which is typically one to two years.
A screenshot posted on Chinese social media during the 2024 rout showed a leveraged snowball contract in which the investor ended up losing all their capital.
Stock declines in 2024 were most pronounced in indexes that were linked to snowballs. There is no proof of a direct impact from snowball liquidations on their underlying indexes.
Investors have been on edge over any possible contagion effect. It can be hard to determine the potential risk from snowballs as it is not even clear how many have been sold.
What has China done to regulate snowballs?
China’s main securities regulator in 2021 asked firms to ensure their snowball products are sold to only qualified investors and that risks are fully disclosed. The Asset Management Association of China, a regulatory association that polices the sector, capped fund investments in snowball products at 25 per cent of a company’s total assets. That did not stop them from ballooning to a scale that threatened markets.
Officials told some of the biggest brokerages in April 2024 to suspend any increase in their net exposure to over-the-counter derivatives involving domestic A shares, including snowball products based on options contracts, Bloomberg reported at the time.
While the restrictions were said to be temporary, the regulators did not indicate when they may be lifted or eased. They also raised a lower limit for investing in snowballs to 10 million yuan (S$1.8 million) from one million yuan to exclude less-experienced investors, and introduced caps on the size of the snowball business.
What is the situation with snowballs today？
China’s wealthy are once again pouring money into snowball-like derivatives, even after the moves to regulate the market. The new versions of these contracts are redesigned with extended maturities and fewer “observation days” – when an index level breach triggers a knock-in.
High-net-worth investors snapped up tens of billions of yuan of revamped snowballs in the first eight months of 2025. China Merchants Bank Co alone has distributed more than 30 billion yuan of such products issued by brokers, Bloomberg reported.
A potential cause for concern is the introduction of so-called Dynamic Coupon Notes that can accommodate smaller investors. They require a minimum investment of one million yuan, have a similar structure and pay coupons of about 1 per cent a month.
What could happen to snowballs after the August rally?
A snowball is essentially a bet that a stock index will trade within the prescribed range designated by the contract, in which case the coupons will be paid in full and the buyer will recoup the full value of their investment.
With most snowball contracts, if the index falls, say, 10 per cent below the lower range and does not recover by the time the snowball matures, an investor stands to lose 10 per cent of their original investment. And during the time the index trades out of the range, coupon payments are put on hold. If the index falls out of the range but moves back into it before maturity, there is no loss on the principal.
In the kind of rally seen in Chinese stocks since April, the risk is that the index remains above the prescribed range, which would deprive the snowball holder of the coupon payments, while not endangering the principal. For example, if the index rises above the range three months after the snowball is sold and stays there, the buyer receives just a quarter of the returns they were due to receive over a year.
How big is the snowball market now?
The contracts are sold individually and there is no single repository for information about the total amount outstanding. In April, CICC estimated that the market for snowballs and dynamic notes was about 100 billion yuan. That is about half the size of what it was at the beginning of 2024.
Back then, ballpark estimates from brokerages put the amount of outstanding contracts between 150 billion and 250 billion yuan, while CICC gave an estimate of 200 billion yuan. The recent high volatility in Chinese stocks means that the amount will be changing constantly.
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