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I hold a call warrant on a stock underlying. The price of the underlying only dropped by 2%. Why did the liquidity provider’s quote for my call warrant fall much more than 2%?

A call warrant is a short-term trading instrument with a gearing effect, it could magnify your loss relative to the underlying performance.

I bought a call warrant on a stock underlying in the morning trading session, when the underlying was traded at HK$50. The underlying price then dropped to HK$48 and the liquidity provider’s quote also dropped. In the afternoon, the price of the underlying went back to HK$50 but the liquidity provider’s quote was still lower than the price at which I bought the call warrant, why?

In addition to the underlying price, the liquidity provider’s quote also depends on a number of other factors. Assuming all other factors remain constant, although the underlying price went back to HK$50 from HK$48, it is likely that the increase in the underlying price was offset or even outweighed by the decrease in the implied volatility of the call warrant, hence lowered the call warrant price.

I note a call warrant launched a week ago was issued at HK$0.25, but its price dropped to HK$0.20 on its first listing date. How could this happen?

The issue price of a call warrant is determined based on the market factors prevailing on the launch date of a warrant. On the first trading day of the call warrant (being 3 trading days after the launch date), it is possible that substantial changes have occurred in respect of the market factors affecting the price of that call warrant.

I hold a call warrant issued by firm A. There was another call warrant with identical terms (same underlying, expiry date and strike price) issued by firm B. Why was price quoted by firm A lower than that quoted by firm B?

In addition to the terms of the call warrant (i.e. underlying, expiry date and strike price), its price also depends on a number of other factors which are based on different pricing assumptions adopted by individual issuers (e.g. different implied volatilities, interest rate, expected dividends, etc.). Moreover, even with identical terms, different call warrants may have a different level of market participation and outstanding amount, which may affect the warrant price to a different extent. Accordingly, the prices of call warrants with identical terms issued by different issuers may vary.

I hold a HSI call warrant which was last traded at HK$0.01. The HSI increased by more than 3% but the liquidity provider refused to quote and the call warrant’s last traded price still remained at HK$0.01. Why didn’t the liquidity provider’s quote increase in line with the underlying?

It is likely that the HK$0.01 last traded (nominal) price could have been brought down a while ago and does not reflect its prevailing theoretical value before the rally of the HSI, hence it is not the best reference to gauge the actual performance of the call warrant.

It is particularly the case for a short term and deep out-of-the-money call warrant. Despite the HSI rallied more than 3%, the warrant is still out-of-the-money with short time to expiry, hence its prevailing theoretical value after the rally of the HSI is still below HK$0.01.

The liquidity provider is not required to provide quote when the theoretical value of the warrant is less than HK$0.01.

A call warrant had 70% of its volume outstanding in the market. Why did the price of the call warrant drop while the price of the underlying remained unchanged?

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

I hold a call warrant which will expire in 10 days. Why did the liquidity provider’s quote fall by 10% despite an increase in the price of the underlying by 1%?

Assuming all other factors remain constant, it is likely that the price of an out-of-the-money and extremely short term call warrant is insensitive to the change in the price of the underlying (due to low delta). It is likely that the liquidity provider’s quote fell despite an increase in the underlying price as such extremely short term call warrant was deeply affected by time decay (much more so than the change in the underlying price).

I hold a very deep in-the-money call warrant linked to HSI and expiring in June (in 2 months) with entitlement ratio 10,000. The delta of the call warrant is almost 1. The HSI index increased 150 points while HSI June futures contracts increased 110 points. The call warrant price increased by HK$0.011 (equivalent to 110 index points) only. Why did it not increase by around HK$0.015 (equivalent to 150 index points)?

HSI call warrants 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 call warrants is generally priced based on HSI futures contracts.

Why does the liquidity provider quote wider spread for a derivative warrant with an illiquid stock underlying than a liquid or blue chip underlying?

A liquidity provider provides quotes for a particular derivative warrant 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.

I hold a call warrant on HSI. I understand the call warrant price should drop as the HSI drops. However, why did the liquidity provider lower the bid price only but not the ask price. This deprives my chance of buying more call warrant at a lower price.

Liquidity providers can provide bid and ask quotes at the pricing level they deem fair by reference to the theoretical price of the call warrant 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 call warrant 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 call warrant to HK$0.197. Notwithstanding the drop in the theoretical price of the call warrant, 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 warrant 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.

I hold a call warrant linked to an HSI constituent security and the entitlement ratio is 1. The closing price of the call warrant and the underlying was as below (please refer to answer below). Why did the closing price of the call warrant drop while the closing price of the underlying increased?

The closing price of the call warrant and the underlying was as below.

Date	Closing price of the call warrant	Closing price of the underlying stock
Previous day	HK$0.120	HK$5.00
Today	HK$0.118	HK$5.02

Date

Closing price of the

call warrant

Closing price of the

underlying stock

Previous day

HK$0.120

HK$5.00

Today

HK$0.118

HK$5.02

This could happen because:

(a) some other pricing factors affected the call warrant price (e.g. volatility, expected dividend, time decay, etc.);

(b) the market closing time of the call warrant 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 call warrant ceased at 4:00 p.m. In this case, due to the 10 minutes closing time gap, direct comparison of closing price of the call warrant and the underlying security might not be appropriate and meaningful, or

(c) the closing price of the call warrant 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 call warrant.The closing price could be (1) calculated based on other exchange participants’ trades and quotes; or (2) carried forward from previous days.

I hold a call warrant with an exercise price of HK$12.28 and the entitlement is 1 share. The underlying company announced a bonus issue of one bonus share for every ten existing shares. How does the bonus issue affect the price and the terms of the call warrant?

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

Where

Adjustment factor = 1 + N
E: Existing entitlement immediately prior to the bonus issue
X: Existing exercise 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)

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.

I hold a call warrant on a stock underlying with its expiry date on 14 June. On 5 April, the underlying declared a final dividend and the ex-dividend date of the underlying falls on 29 May. The ex-dividend date of the final dividend for last year was 17 June. How does this affect the price of the call warrant?

Assuming all other factors remain unchanged, the call warrant 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 call warrant is higher than expected (according to historical record it was expected that such dividend would only be paid after the expiry of the call warrant).