Pricing Cases

In addition to the term of CBBC (i.e. underlying, expiry date, strike price and call price), the price of a CBBC also depends on a number of other factors which are based on different pricing assumptions adopted by individual issuers (e.g. different funding level, hedging cost, expected dividends, etc.). Accordingly, the prices of CBBCs with identical terms issued by different issuers may be different.

Assuming all other factors remain constant, it is likely that the bull CBBC price is affected by market force. The higher the outstanding amount, the greater the potential that the bull CBBC price is affected by market supply and demand, and as a result of which the bull CBBC price may drop due to the high selling pressure while the price of the underlying remained unchanged. 

HSI bull CBBCs are not solely priced based on HSI index. They are mainly priced based on HSI index, interest rate and expected dividend. Since HSI futures contract reflects the value of HSI index, interest rate and expected dividend, the pricing of the HSI bull CBBCs is generally priced based on HSI futures contracts.

The price of such CBBC is based on the estimated future price of the HSI futures expiring in 6 months against which the CBBC is hedged (rather than the spot level of the HSI or the future price of the front month HSI futures). The estimated future price of the HSI is calculated by reference to the sum of the cash value of the HSI (based on the HSI’s level) and interest rate, less the expected dividend. Assuming all other factors remain constant, it is likely that such increase in the spot level of the HSI was offset by the adjustment of expected dividend by the issuer, and hence the price of the CBBC remained unchanged. 

This is because the delta of the bull CBBC is not exactly equal to 1. Besides, there are a number of different factors which may affect the price of a CBBC other than underlying spot such as expected dividend and funding cost. 

When the underlying price is trading close to the call price, the price of the CBBC may become more volatile and the change in the price of the CBBC may be disproportionate to the change in the underlying price. Investors should also be aware of the number of outstanding CBBC in the market. The higher the outstanding number, the greater the selling pressure when the underlying price gets closer to the call price. This leads to a more volatile price behaviour.

A liquidity provider provides quotes for a particular CBBC by taking into consideration the prevailing market conditions such as hedging costs and the liquidity, spread and volatility of the relevant hedging vehicles. Normally, blue chip stocks have better liquidity which allows liquidity provider to provide a tighter quote than illiquid underlying.

Liquidity providers can provide bid and ask quotes at the pricing level they deem fair by reference to the theoretical price of the bull CBBC provided that they comply with the maximum spread requirements. The bid and ask spread may change from the time to time according to the prevailing market conditions affecting the underlying asset such as hedging costs and liquidity, spread and volatility of the relevant hedging vehicles.  Therefore it is possible that their quotes will not match your expected price levels due to the widening of the bid and ask spread.

For example, we assume that the theoretical price of the bull CBBC was initially HK$0.2 with a spread of HK$0.003 on each side, such that the bid and ask quotes were initially HK$0.197 and HK$0.203 respectively. The HSI then drops which leads to a corresponding drop in the theoretical price of the bull CBBC to HK$0.197. Notwithstanding the drop in the theoretical price of the bull CBBC, the spread may be widened to reflect the prevailing market conditions. For example, if the spread is then widened to HK$0.006 on each side. The new bid and ask quotes will become HK$0.191 and HK$0.203 respectively for the CBBC with a theoretical price of HK$0.197. In such case, the ask quote does not change but the bid quote is lowered due to the widened spread.

This could happen because:

1. some other pricing factors affected the bull CBBC price (e.g. expected dividend, time decay, etc.);
2. the market closing time of the bull CBBC and the underlying security was different. Being an eligible security under the closing auction session, it continued to trade in the closing auction session which ended at 4:10 p.m. while the trading in the bull CBBC ceased at 4:00 p.m. In this case, due to the 10 minutes closing time gap, direct comparison of closing price of the bull CBBC and the underlying security might not be appropriate and meaningful, or

    

3. the closing price of the bull CBBC might not reflect the quote price of the liquidity provider. In this case, quotes of the liquidity provider might have moved in line with the underlying but were not reflected in the closing price of the bull CBBC.  The closing price could be (1) calculated based on other exchange participants’ trades and quotes; or (2) carried forward from previous days.

CBBCs can be knocked out during the observation period which includes pre-opening session, continuous trading session and closing auction session. Even though the trading in the CBBC ceased at the end of the continuous trading session at 4:00 p.m., it could still be knocked out when the underlying stock hits the call price at the end of the closing auction session.

The entitlement and exercise price of the call warrant will be adjusted according to the following formula:

Adjusted entitlement = Adjustment factor * E

Adjusted exercise price = X / Adjustment factor

Adjusted call price = Y / Adjustment factor

Where

• Adjustment factor = 1 + N
• E:  Existing entitlement immediately prior to the bonus issue
• X:  Existing exercise price immediately prior to the bonus issue
• Y: Existing call price immediately prior to the bonus issue 
• N:  Number of additional shares received by a holder of existing shares for each share held prior to the bonus issue

In this case,

• Adjustment factor = 1+ 1/10 = 1.1
• Adjusted entitlement = 1 * 1.1 = 1.1 shares
• Adjusted exercise price = HK$12.28/1.1 = HK$11.164 (rounded to the nearest HK$0.001)
• Adjusted call price =HK$12.88/1.1=HK$11.709 (rounded to the nearest HK$0.001)

The purpose of the adjustment is to ensure that as far as possible, the theoretical price of the call warrant remains unchanged immediately before and immediately after the adjustment. Assuming all factors being equal, the theoretical price of the call warrant will remain unchanged.

Assuming all other factors remain unchanged, the bull CBBC price will drop upon declaration of dividend on 5 April.  It is because the actual ex-date (29 May) falls before the expiry date (14 June) and the dividend actually paid during the term of the bull CBBC is higher than expected (according to historical record it was expected that such dividend would only be paid after the expiry of the bull CBBC).