Frequently Asked Questions 
24/02/2012 
 

Chapter 6 Products - Securities Market

6.6

Callable Bull/Bear Contracts (CBBC

General Features

6.6.1    

What are CBBC?

Like derivative warrants, CBBC are structured products.  They are leveraged investments that track the performance of the underlying assets without requiring investors to pay the full price required to own the actual assets. They are issued either as Bull or Bear contracts, allowing investors to take bullish or bearish positions on the underlying assets. BBC are issued by a third party, usually an investment bank, independent of HKEx and of the underlying assets.

CBBC may be issued with a lifespan of three months to five years and are settled in cash only.  CBBC are issued with the condition that during their lifespan they will be called by the issuers when the price of the underlying assets reaches a level (known as the Call Price) specified in the listing document.  If the Call Price is reached before expiry, the CBBC will expire early and the trading of that CBBC will be terminated immediately.  The specified expiry date from the listing document will no longer be valid.

 

6.6.2

What are the major features of CBBC?

Major features of CBBC include:

i.

CBBC price moves tend to track the price moves of the underlying assets closely

The price of a CBBC tends to follow closely the price of the underlying assets (ie delta close to one).  Thus, if the underlying assets increase in value, a Bull CBBC with entitlement ratio of 1 to 1 generally increases in value by approximately the same amount, whereas a Bear CBBC with entitlement ratio of 1 to 1 generally decreases in value by approximately the same amount.  Due to this property, CBBC issuers offer investors a product which tracks the price movement of the underlying assets more closely and with higher price transparency than some other structured products. However, when the underlying assets of a CBBC are trading at a price close to its Call Price, the value of CBBC may become more volatile and the change in its value may be disproportionate to the change in the value of the underlying assets.
 

ii.

CBBC have a Call Price and a mandatory call feature

For Bull contracts, the Call Price must be either equal to or above the strike price.  For Bear contracts, the Call Price must be equal to or below the strike price.  If the underlying assets’ price reaches the Call Price at any time prior to expiry, the CBBC will expire early.  The issuer must then call the CBBC and trading of the CBBC will be terminated immediately.  Such an event is referred to as a mandatory call event (MCE).
 

iii.

Categories of CBBC

There are two categories of CBBC, namely Category N CBBC and Category R CBBC.

  • A Category N CBBC refers to a CBBC where its Call Price is equal to its strike price, and the CBBC holder will not receive any cash payment once the price of the underlying assets reach or go beyond the Call Price.
  • A Category R CBBC refers to a CBBC where its Call Price is different from its strike price, and the CBBC holder may receive a small cash payment (called "residual value") upon the occurrence of an MCE but in the worst case, no residual value will be paid (Category N CBBC do not have residue value).

When a Category R Bull contract is called, the residual value will be the positive amount of the settlement price as determined according to the terms in the listing document less the strike price.  The settlement price of a Bull contract must not be lower than the minimum trade price of the underlying assets after the MCE and up to the next trading session.  Similarly, when a Category R Bear contract is called, the residual value will be the positive amount of the strike price less the settlement price as determined according to the terms in the listing document.  The settlement price of a Bear contract must not be higher than the maximum trade price of the underlying asset after the MCE and up to the next trading session.  For this purpose, the pre-opening session and morning session are considered as one trading session.  In the cases where the settlement price is at or goes beyond the strike price, there may be no residual value.

Comparing a Category N CBBC and a Category R CBBC with the same strike price, the Category R CBBC may be called at a lower level than the Category N CBBC.  

iv.

Valuation at Expiry

CBBC can be held until maturity (if not called before expiry) or sold on the Exchange during trading hours before expiry. 

a.

In the case of a Bull contract, the cash settlement amount at normal expiry will be the positive amount of the settlement price of the underlying assets as determined on the valuation day less the strike price. 

b.

In the case of a Bear contract, the cash settlement amount at normal expiry will be the positive amount of the strike price less the settlement price of the underlying assets on valuation day. 

For CBBC with shares of a Hong Kong-listed company as underlying assets, the settlement price of the CBBC will be the closing price of the underlying shares on the last trading day.  For CBBC linked to the Hang Seng Index or Hang Seng China Enterprises Index, the settlement level of the CBBC will be the same as the index level for settling the relevant expiring index futures contract.  There will be no cash settlement if the amounts calculated under a and b are negative.  For the settlement price of CBBC with overseas stocks, commodities or other indices as underlying assets, investors should refer to the details in the listing documents.

 

6.6.3

How do CBBC work?   

A CBBC is generally issued at a price that represents the difference between the spot price of the underlying assets and the strike price of the CBBC, plus funding costs.  For Bull contracts, the Call Price can be equal to or higher than the strike price, whereas for Bear contracts, the Call Price can be equal to or lower than the strike price.  The following example illustrates how a Bull contract works:

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

At the time of issuance

Underlying assets

Shares of Company X

Spot price

$110

Call Price (fixed at issue)

$90

Strike price (fixed at issue)

$90

Funding costs (8%)

$7.2

Contract entitlement

100 : 1

Expiry

12 months

Theoretical price at issue:
[(spot price - strike price + funding costs)/entitlement]

$0.272

Value of one board lot (10,000 shares)

$2,720

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

MCE occurs

The Bull contract is called and trading is terminated

There will be no residual payment

Net loss will be the original investment of $2,720

If not called before expiry, at expiry:

Price of shares of Company X:

$130

Settlement amount of a Bull contract
(settlement price* - strike price)/entitlement
= ($130 - $90)/100
*Settlement price is the closing price of shares of company X on the last trading day

$0.4

 

Value of one board lot

$4,000

Payoff of one board lot
(value of  the Bull contract CBBC at expiry - original investment)
= $4,000 - $2,720

Rate of return
= $1,280 / $2,720

 

$1,280


47%

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

At the time of issuance

Underlying asset

Shares of Company X

Spot price

$110

Call price (fixed at issue)

$95

Strike price (fixed at issue)

$90

Funding costs (8%)

$7.2

Contract entitlement

100 : 1

Expiry

12 months

Theoretical price at issue:
[(spot price - strike price + funding costs)/entitlement]

$0.272

Value of one board lot (10,000 shares)

$2,720

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

MCE occurs

 

Residual value of the Bull contract at call:
(settlement price* - strike price)/entitlement
=($94 - $90)/100


*Settlement price as determined according to the terms in the listing document which must not be lower than the minimum trade price of the underlying asset after the MCE and up to the next trading session.  It is assumed to be $94 in this example.  If the settlement price is determined to be equal to or less than the strike price, no residual payment will be received.  The total loss will be the original investment amount.

$0.04                

 

Value of one board lot

$400

Net loss of one board lot ($2,720 - $400)

$2,320

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.

 

6.6.4

What are the differences between CBBC and derivative warrants?

CBBC and derivative warrants are both structured products traded on the Stock Exchange, HKEx’s securities market, and they share some characteristics.  A comparison of the two products appears below.

 

CBBC

Derivative warrants

Issuer

 

Eligible Issuers

Trading platform

 

The HKEx securities market’s electronic trading systems

Trading currency

 

Hong Kong dollars or US dollars

Minimum issuance size and issue price

Minimum issuance size is $10 million and minimum issue price is $0.25 per CBBC/derivative warrant

 

Response to price movement in underlying assets

 

Changes in value by approximately the same amount as the underlying assets

Depends on various factors

Implied volatility

Insignificant to pricing

Affects pricing

 

Funding costs

The formula for calculating funding costs is specified in the listing document

The funding costs are built into the premium of the derivative warrant

 

Duration

 

3 months to 5 years

6 months to 5 years

Capital adjustment

For CBBC on Hong Kong-listed stocks, adjustments follow prevailing principles of stock futures/stock options, where applicable (for details, please refer to sections on stock futures/stock options)

As stated in the listing documents issued by the issuers; usually no adjustment for ordinary dividends.  Some issuers may adjust for special dividends, some may not.

 

Maximum loss

Limited to the amount invested by holders

 

Mandatory call

CBBC must be terminated early when the underlying assets’ price hits the Call Price

Standard (ie non-exotic)  derivative warrants will not be terminated early

 

Settlement price/level at expiry

Closing price of the underlying assets on last trading day if underlying assets are shares of a Hong Kong-listed company;

Index level for settling the corresponding index futures contract of the same expiry month if it is a CBBC on the Hang Seng Index or H-shares index


Refer to the listing documents for CBBC with other underlying assets.

 

Five days average closing price before expiry day if underlying assets are shares of a Hong Kong-listed company;

Index level for settling the corresponding index future contract of the same expiry month if the derivative warrant and futures contract have the same expiry day if it is a derivative warrant on the Hang Seng index

Refer to the listing documents for derivative warrants with other underlying assets.  

 

Short position

Bear contracts

Put warrants

 

Margin requirement

 

None

Underlying assets

 

A range of underlying assets which is updated from time to time

 

6.6.5

What are the risk factors to be considered before investing in CBBC?

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.

 

Trading Arrangements

6.6.6

Will there be any adjustment to the terms of a CBBC if there is a capital adjustment of the underlying assets?     

For CBBC on Hong Kong-listed shares of a company, adjustment of the contract due to a capital adjustment of the underlying shares will follow the prevailing principles for stock futures/stock options (when applicable).  Adjustment will be made to the Call Price, strike price and entitlement ratio according to terms specified in the listing documents.

 

6.6.7

What if trading in the underlying shares of a CBBC is suspended?

If trading in the underlying shares is suspended and the shares are listed on the Stock Exchange, trading in the related CBBC will also be suspended from until trading of the underlying shares resumes.  For trading suspensions involving overseas stocks, investors should refer to the arrangements stated in the CBBC’s listing documents.  

 

6.6.8

When is the last trading day of a CBBC?  Can CBBC be sold after the MCE?

Each CBBC is assigned a unique expiry date at launch.  If a CBBC is called before expiry, the day on which the CBBC is called (the date on which an MCE occurs) is the last trading day of that CBBC.  When an MCE occurs, the CBBC will be called by the issuer and trading of that CBBC will terminate at once, hence investors cannot sell the CBBC.  The last trading day will be one trading day before the expiry day of the CBBC if it has not been called.  Investors should note that this arrangement is different from the arrangement for derivative warrants, which have their last trading day four days before the expiry day.

 

6.6.9

What does the short name of a CBBC tell?  How can investors differentiate a CBBC from derivative warrant by using the short names? 

Investors can learn some basic features of a CBBC from its stock short name.  Below are the naming conventions for reference.   

Z

Z

#

Q

Q

Q

Q

Q

N

C

Y

Y

M

M

A

Or (traded in Renminbi)

Z

Z

#

Q

Q

Q

Q

N

C

Y

Y

M

M

A

*

ZZ

Issuer's short name

#

CBBC indicator

Q

Up to 5 characters representing name of the underlying asset

N

N = No residual value ; R = With residual value

C

C = Bull contract ; P = Bear contract

YYMM

Expiry year and month

A

Serial number for additional issues by the same issuer on same underlying asset with same expiry year and month (A, B, C ...)

*

Indicator for CBBCs traded in Renminbi (RMB)

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 “Securities Products” under the "Products & Services" section of the HKEx website.

Liquidity Provision 

6.6.10

What are the obligations of a liquidity provider?

The listing document sets out the exact obligations of the liquidity provider.  In normal circumstances, liquidity providers should provide liquidity for CBBC issues through continuous quotes or in response to quote requests from five minutes after the market opens to until the market closes.  The liquidity provider should provide liquidity for at least 10 board lots of the CBBC.  An issuer must specify the maximum spread between the bid and offer prices for its CBBC and the maximum response time in the listing document.  Under the quote request system, investors may request a quote from the liquidity provider.

 

6.6.11

How can investors contact liquidity providers to request quotes?

An investor can request a quote from a liquidity provider if the listing document states that quotes are provided upon request.  For CBBC with liquidity providers that respond to quote requests, the telephone numbers of the liquidity providers are available in the listing documents, on the HKEx website and on the CBBC stock page of the Exchange’s trading system. 

For further details, please refer to "Callable Bull/Bear Contracts" of "Securities Products" under the "Products & Services" section of the HKEx website.