Pricing Parameters and Ratios

The entitlement ratio for a CBBC is the number of such products required to be converted into a unit of the underlying asset at the strike price on the expiry date. Assuming all other factors affecting two different products are the same (underlying asset, strike price, expiry date, volatility etc.), their respective entitlement ratios would directly affect their respective values per unit. Generally, a CBBC with a higher entitlement ratio would have a relatively small value per unit. However, in theory, the entitlement ratio would not affect the performance of a particular product, as it has been calculated into the effective gearing.

The premium reflects the degree by which the price of the underlying asset needs to move before reaching the break-even price of a CBBC at expiry.

For example, if the premium of a bull CBBC is 10%, the underlying price should rise by 10% at expiry, in order to reach the break-even price.

You can calculate the premium based on the formula below (based on the payout formula at expiry):

These formulae can therefore be used as a reference to calculate the percentage by which the price of the underlying asset needs to move before reaching the break-even price of a CBBC at expiry.

These formulae can therefore be used as a reference to calculate the percentage by which the price of the underlying asset needs to move before reaching the break-even price of a CBBC at expiry.

In calculating the premium for a bull CBBC linked to the HSI based on the below formula, we need to determine the underlying price for the HSI. The spot level of the HSI may differ from its estimated future price, because 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 spot level) and interest rate, less the expected dividends. In most cases, as the expected dividends would be higher than the interest rate, such estimated future price of the HSI is therefore often lower than the cash value of the HSI’s spot level.

The premium calculated pursuant to the below formula may therefore be different depending on whether you apply (i) the spot level of the HSI as the underlying price, or (ii) the estimated future price of the HSI as the underlying price.

However, as the product price of a CBBC linked to the HSI is generally based on the estimated future price of the HSI futures expiring in 6 months (rather than the spot level of the HSI), such estimated future price should be adopted as the underlying price for calculating the premium of the CBBC. It is therefore likely that the premium calculated based on such lower estimated future price may result in a positive premium, whereas the premium calculated based on the spot level of the HSI may result in a negative premium, using the below formula.

Delta is the ratio of the change in the CBBC price (after adjusted by the entitlement ratio) to the change in the underlying asset’s price.

“Gearing” means the relationship that the cost of the underlying asset bears to the cost of a CBBC. For example, if the gearing for a particular CBBC is 10 times, then the investment cost of that CBBC is 1/10 of the underlying asset.

A number of other factors affecting the price of the CBBC may also change over time and, therefore, a mere rise in the underlying asset’s price may not necessarily lead to a corresponding increase to the extent of the effective gearing, or to any increase at all in the CBBC’s price.