Investing in derivative warrants is not suitable for everyone. Derivative warrants involve a high degree of risk and you must be comfortable with that risk before investing. The relevant listing documents disclose the key risks applicable to the relevant derivative warrants. You must consider and understand those risks. You must also be able to assume the risks, which includes being financially able to bear the potential losses in a “worst case” scenario.
Generally speaking, the key risks include the following:
(a) Non-collateralisation - Derivative warrants are not secured by any asset of the issuer or the guarantor (if any) or supported by any other collateral.
(b) Credit risk - Holders of derivative warrants are unsecured creditors of the issuer and the guarantor (if any) and they have no preferential claim to any assets that an issuer or a guarantor (if any) may hold. When you purchase derivative warrants, you are relying upon the creditworthiness of the issuer and/or a guarantor (if any). You can access information about issuers’ (or their guarantors’) credit ratings on their own website or the HKEX’s website.
(c) Gearing risk - Although these products often cost less than the underlying assets, they may change in value to a much greater extent than the underlying assets. Although the potential return on such products may be higher than that on the underlying assets, in the worst case the value of these products may fall to zero and holders may lose their entire investment amount.
(d) Limited life - Unlike stocks, derivative warrants have an expiry date and therefore a limited life.
(e) Time value - So long as other factors remain unchanged, the time value of derivative warrants will decrease over time and will become zero upon maturity. Therefore, without a strong view of the underlying assets, derivative warrants should be viewed as a relatively short-term investment product in comparison with an investment in the underlying assets.
(f) Market forces - In addition to the basic factors that determine the theoretical price of a derivative warrant, prices of derivative warrants are also affected by the demand for and supply of the derivative warrants. This is particularly the case when the existing issuance of a single series of derivative warrants are almost sold out and when there are further issues in that single series of derivative warrants.
(g) Turnover ‐ High turnover should not be regarded as an indication that the price of a derivative warrant will go up. The price of a derivative warrant is affected by a number of factors in addition to market forces, such as the price of the underlying assets and their volatility, the time remaining to expiry, interest rates and the expected dividend on the underlying assets.
(h) Possibly limited secondary market - The liquidity provider may be the only market participant for a particular derivative warrant. The more limited the secondary market, the more difficult it may be for you to realise the value in the derivative warrant before expiry.
(i) Operational and technical problems affecting liquidity services - The liquidity provider may not be able to provide liquidity when there are operational and technical problems hindering its ability to do so. Even if the liquidity provider is able to provide liquidity in such circumstances, its performance on liquidity provision may be adversely affected. For example:
i. the spread between bid and ask prices quoted may be significantly wider than its normal standard;
ii. the quantity for which liquidity will be provided by the liquidity provider may be significantly smaller than its normal standard; and
iii. the liquidity provider’s response time for a quote may be significantly longer than its normal standard.
(j) Corporate action of the underlying stocks - Corporate actions affect the value of the underlying stocks which in turn affect the value of the derivative warrants. Adjustments may or may not be made to the terms of the derivative warrants (such as entitlement ratio, exercise price, etc.) depending on the terms and conditions set out in the listing documents.
Where adjustments are to be made, the adjustments will only become effective (the “Effective Date”) when all necessary parameters can be determined.
The prices of the derivative warrants may be volatile from the ex-entitlement date of the underlying stocks until the Effective Date. You should exercise particular caution in trading those derivative warrants during that period. In addition, no adjustment will be made to those derivative warrants that expire within that period.
You should read carefully the risk disclosure in the relevant listing documents of the derivative warrants before investing in such products.