Callable Bull/Bear Contracts

Example 1: Category N Bull Contract (Without residual value)

At the time of issuance

If spot price falls to $90 (ie the Call Price)

If not called before expiry, at expiry:

Example 2: Category R Bull Contract (With residual value)

At the time of issuance

If spot price falls to $95 (ie the Call Price)

If not called before expiry, the payoff will be the same as Example 1 above.

The calculation of profit and loss in the two examples above has not taken into account the brokerage commission and other transaction costs.

The issue price of a CBBC includes funding cost and issuers are required to specify the formula for calculating the funding costs of their CBBC at launch in the listing documents.  The funding cost of a CBBC includes the issuer's financing/stock borrowing costs after adjustment for expected ordinary dividends of the shares (if the underlying assets are dividend-paying shares) and the issuer's profit margin.  These items fluctuate from time to time, therefore the funding costs are not fixed throughout the tenure of the contracts.  In general, the longer the duration of the CBBC, the higher the funding costs.  The funding costs decline over time as the CBBC moves towards expiry.  Investors are advised to compare the funding costs of different issuers of CBBC with similar underlying assets and features.

Investors should take into account the following risk factors (among others):

1. Mandatory call
   
   CBBC are a type of leveraged investment.  They may involve a higher degree of risk and are not suitable for all types of investors.  Investors should consider their risk appetite prior to buying CBBC.  In any case, one should not trade in CBBC unless he/she understands the nature of the product and is prepared to lose the total amount invested, since a CBBC will be called by the issuer when the price of the underlying assets hits the Call Price, and that CBBC will expire early.  The payoff for Category N CBBC is zero when they expire early.  When Category R CBBC expire early the holder may receive a small residual value payment, but there may be no residual value payment in some situations.  Dealers may charge their clients a service fee for the collection of the residual value payment from the respective issuers.
   
   In general, the larger the buffer between the Call Price and the spot price of the underlying assets, the lower the probability of the CBBC being called, since the underlying assets of that CBBC would have to experience a larger movement in their price before it is called.  However, the larger the buffer, the lower the leverage effect.
   
   Once the CBBC is called, even though the underlying assets may bounce back in the right direction from the investors' point of view, the CBBC which has been called will not be revived and investors will not be able to profit from the bounce-back.
   
   Besides, the MCE of a CBBC with underlying assets overseas may be triggered outside Stock Exchange trading hours.
   
   
2. Gearing effect
   
   Since a CBBC is a leveraged product, the percentage change in its price is greater compared with that of its underlying assets.  Investors may suffer higher losses in percentage terms if they expect the price of the underlying assets to move one way but it moves in the opposite direction.
   
   
3. Limited life
   
   A CBBC has a limited lifespan, as denoted by the fixed expiry date, of three months to five years.  The life of a CBBC may be shorter if called before the fixed expiry date.  The price of a CBBC fluctuates with the changes in the price of the underlying assets.  A CBBC may become worthless after expiry or if the CBBC has been called early.
   
   
4. Movement of underlying assets’ price
   
   Although the price of a CBBC tends to follow closely the price of its underlying assets, in some situations it may not (ie delta may not always be close to one).  The price of a CBBC is affected by a number of factors, including demand for the CBBC and the supply, funding costs and time to expiry.  Moreover, the delta for a particular CBBC may not always be close to one, in particular when the price of the underlying assets is close to the Call Price.
   
   
5. Liquidity
   
   Although CBBC have liquidity providers, there is no guarantee that investors will be able to buy/sell CBBC at their target prices any time they wish. 
   
   
6. Funding costs
   
   When a CBBC is called, the CBBC holders will lose the funding cost for the full period, since the funding cost is built into the CBBC price upfront at launch, even though the actual period of funding for the CBBC turns out to be shorter when there is an MCE.  In any case, investors should note that the funding costs of a CBBC after launch may vary during its life and the liquidity provider is not obliged to provide a quote for the CBBC based on the theoretical calculation of the funding costs for that CBBC at launch.
   
   
7. Trading of CBBC close to Call Price
   
   When the underlying assets are trading close to the Call Price, the price of a CBBC may become more volatile with wider spreads and uncertain liquidity.  CBBC may be called at any time and trading will terminate as a result.
   
   All trades executed after an MCE (ie Post MCE Trades) will not be recognised and will be cancelled. Since there may be a time lapse between the MCE and termination of trading of the CBBC, some Post MCE Trades may be cancelled even though they may have been confirmed by brokers.  Investors should therefore apply special caution when a CBBC is trading close to the Call Price.
   
   Issuers will announce the exact call time within one hour after the trigger of the MCE, and the Exchange will send the list of Post MCE Trades to the relevant brokers who in turn will inform their clients accordingly.  If investors are not clear whether their trades are Post MCE Trades or if they have been cancelled, they should check with their brokers.
   
   
8. CBBC with overseas underlying assets
   
   Investors trading CBBC with overseas underlying assets are exposed to an exchange rate risk as the price and cash settlement amount of the CBBC are converted from a foreign currency into Hong Kong dollars.  Exchange rates between currencies are determined by supply and demand, which are affected by various factors.
   
   Besides, CBBC issued on overseas underlying assets may be called outside the Stock Exchange’s trading hours.  In such cases, the CBBC will be suspended from trading on the Exchange in the next trading session or soon after the issuer has notified the Exchange about the occurrence of the MCE. There will be no automatic suspension of CBBC by the trading systems of HKEX’s securities market upon occurrence of an MCE.  For Category R CBBC, valuation of the residual value will be determined on the valuation day according to the terms in the listing documents.  In general, stamp duty is not applicable to cash-settled CBBC, but investors are advised to refer to the listing documents for information regarding stamp duty.

 

The “#” sign in the stock short name could help investors differentiate a CBBC from a derivative warrant.

Investors should note that the above naming conventions are applicable in most cases but not exclusive for all circumstances. The short names of CBBCs indicate some basic information only. Investors should refer to the listing documents of issuers and consult their brokers or investment advisers before trading. Listing documents can be found at “Product Search” under the "Structured Products" of "Products" section of the HKEX website.