CBBC Guide Eng A4Version Final 19 Feb 2010 (Web)
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Transcript of CBBC Guide Eng A4Version Final 19 Feb 2010 (Web)
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bmarkets.com
CALLABLE BULL/BEARCONTRACTS (CBBC) GUIDE
CBBC
Trade fast, trade up.
speed
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CBBC QUIZ
WHAT ARE CBBC?
HOW ARE CBBC PRICED?
MANDATORY CALL MECHANISM OF CBBC
DIFFERENCE BETWEEN CATEGORY R CBBC AND CATEGORY N CBBC
CBBC PROFIT AND LOSS ANALYSIS
HOW DOES EXERCISE PRICE AFFECT GEARING RATIO?
CONVERSION RATIO AND ITS RELATIONSHIP WITH SENSITIVITY
INTERPRETING THE NAME OF CBBC
COMPARISON BETWEEN CBBC AND WARRANTS
CBBC SETTLEMENT PROCEDURE
INVESTMENT RISKS OF CBBC
FIVE STEPS TO CHOOSE A CBBC
GLOSSARY
CONTENTS
1
3
4
6
7
8
10
11
12
13
14
15
17
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CBBC were introduced in Hong Kong in June 2006. Similar to warrants, CBBC are listed on the Hong Kong
Stock Exchange. The prices of CBBC depend mainly on the price of the underlying asset and the
underlying assets range from local to foreign indices or shares, commodities or currencies.
A feature of CBBC which investors should familiarise themselves with is the mandatory call mechanism.
This mechanism, where trading of CBBC will terminate immediately upon the underlying asset price
reaching the “call” level, has significant impact on the investment. Details of this feature will be further
discussed in Section MANDATORY CALL MECHANISM OF CBBC.
There are two categories of CBBC: Category R and Category N. They differ in terms of the call price and the
consequences after a mandatory call event has been triggered. This will be discussed in further details in
Section DIFFERENCE BETWEEN CATEGORY R CBBC AND CATEGORY N CBBC.
The gearing effect of a CBBC magnifies the investment returns or losses in a similar manner. It allows
investors to achieve similar investment returns or incur similar losses with a fraction of the investment
capital if they were to invest directly in the underlying asset. Bullish investors can consider Callable Bull
Contracts while bearish investors can consider Callable Bear Contracts.
Pricing of CBBC is relatively straight forward and easy to understand. However, investors should be aware
of the funding costs charged by the issuers. This will be further discussed in Section HOW ARE CBBC
PRICED?.
WHAT ARE CBBC?
3
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Investors should understand the mandatory call mechanism before investing in CBBC. A call level is a preset
level of the underlying asset which defines the continuity of a CBBC before the expiry date.
During a trading session, if the underlying asset price of a CBBC reaches the call price, a mandatory call event
will be triggered and trading of that CBBC will be terminated immediately and the CBBC will be delisted. For
example, if an investor holds a Hang Seng Index Callable Bull Contract which has a call level of 19,800 points,
and the Hang Seng Index falls to 19,800 points, the trading of that CBBC will be terminated immediately even if
the Hang Seng Index rebounds within a short time after the occurrence of the mandatory call event.*
Investors’ entitlement following the occurrence of a mandatory call event will depend on the category of
CBBC. Category N CBBC have no residual value, hence, investors of Category N CBBC will not receive any
cash payment after a mandatory call event occurs. On the other hand, investors of Category R CBBC will, in
most cases, be able to receive the residual values of the CBBC after a mandatory call event occurs.
However, the residual values will be less than the price investors paid for purchasing the CBBC and
therefore the investors may suffer a loss. Details about Category N and Category R CBBC and their
difference will be explained further in Section DIFFERENCE BETWEEN CATEGORY R CBBC AND CATEGORY
N CBBC.
Please note the settlement price in the above formulae means, in respect of a Callable Bull Contract, thelowest trading price during the observation period and in respect of a Callable Bear Contract, the highest
trading price during the observation period. The observation period commences immediately after the
mandatory call event occurred until the next complete trading session.
In cases where the market is extremely volatile where the settlement price is lower than the exercise price
of a Callable Bull Contract or the settlement price is higher than the exercise price of a Callable Bear
Contract, the residual value will be zero.
* Please note that the examples and figures set out in this section are purely hypothetical. They are solely
for illustration purposes and MUST NOT be relied on as indications of the actual returns or what the
payouts or performance of the CBBC might be.
MANDATORY CALL MECHANISM OF CBBC
( Settlement Price − Exercise Price )
Conversion RatioResidual Value of Callable Bull Contract =
( Exercise Price − Settlement Price )
Conversion RatioResidual Value of Callable Bear Contract =
The formulae set out below show the calculations of residual values of Category R CBBC:
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There are two categories of CBBC: Category R CBBC and Category N CBBC. The main difference is that the
exercise price is identical to the call price for a Category N CBBC, while the exercise price and call price for
a Category R CBBC are different.
Because the call price and the exercise price of a Category N CBBC are the same, when the underlying
asset price reaches the call price (i.e. when a mandatory call event occurs), the intrinsic value is zero.*
Conversely, the call price and the exercise price of a Category R CBBC are set at different prices. When a
mandatory call event occurs, the intrinsic value of a Category R CBBC will usually be greater than zero.
Unless the market is extremely volatile where the settlement price is lower than the exercise price (for
Callable Bull Contract) or higher than the exercise price (for Callable Bear Contract), there will be a residual
value distributed to the investors. However, the residual values will normally be less than the price the
investors paid for purchasing the CBBC and therefore the investors may suffer a loss.
In summary, after a mandatory call event is triggered, investors of Category R CBBC in most cases are to
recover a residual value although the residual value will normally be less than the price paid by the
investors for purchasing the CBBC and therefore they will incur a loss. On the other hand, investors of
Category N CBBC will not receive any residual value after a mandatory call event is triggered.
The table below gives a brief overview of CBBC in general:
* Intrinsic value of a Callable Bull Contract = underlying asset price – exercise price
Intrinsic value of a Callable Bear Contact = exercise price – underlying asset price
DIFFERENCE BETWEEN CATEGORY R CBBC AND CATEGORY N CBBC
7
Category
Callable Bull Contract Callable Bear Contract
Prediction of the
underlying asset
Relationship betweencall price and
exercise price
Residual value
Category R
Callable Bull
Contract
Bullish
Call price >
Exercise price
Yes in most cases
Category N
Callable Bull
Contract
Bullish
Call price =
Exercise price
No (zero)
Category R
Callable Bear
Contract
Bearish
Call price <
Exercise price
Yes in most cases
Category N
Callable Bear
Contract
Bearish
Call price =
Exercise price
No (zero)
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N.B. If the Callable Bull Contract is called, the residual value does not include funding cost.
Scenario B: Spot price of Stock A reaches the call price of HKD 120.00 before the expiry with all the other
factors remaining the same:
Scenario C: Spot price of Stock A increases to HKD 170.00 on the expiry date with all the other factors
remaining the same:
9
Price of Callable Bull Contract( HKD 170.00 - HKD 100.00 )
10= HKD 7.00=
Gain in underlying share price: HKD 20.00 or 13.33%
Gain in Callable Bull Contract: HKD 1.00 or 16.67%
N.B. When the Callable Bull Contract expires, there is no more funding cost.
N.B. If the Callable Bull Contract is called, the residual value does not include funding cost. In cases where
the residual value is negative, the investors will not receive any cash payment and will lose their entire
investment principal as a result.
Scenario D: Spot price of Stock A reaches the call price of HKD 120.00 and continues to fall through
HKD 100.00 within the same trading day with all the other factors remaining the same:
Residual Value( HKD 120.00 - HKD 100.00 )
10= HKD 2.00=
Spot Price of Stock A has fallen to HKD 120.00 and settlement price is therefore HKD 120.00
(Note: The settlement price of the Callable Bull Contract must not be
lower than the minimum trading price of the underlying asset during the period
between the mandatory call event and up to and including the next trading session.)
The Callable Bull Contract is being called, the residual value is:
Loss in underlying share price: HKD 30.00 or 20.00%
Loss in Callable Bull Contract: HKD 4.00 or 66.67%
Price of Callable Bull Contract( HKD 95.00 - HKD 100.00 )
10= HKD -0.50=
Spot Price of Stock A has fallen to HKD 95.00 and settlement price is therefore HKD 95.00(Note: The settlement price of the Callable Bull Contract must not be lower
than the minimum trading price of the underlying asset during the period between
the mandatory call event and up to and including the next trading session.)
The Callable Bull Contract is being called, the residual value is:
Loss in underlying share price: HKD 55.00 or 36.67%
Loss in Callable Bull Contract: HKD 6.00 or 100.00%
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As discussed in the previous section, the gearing ratio of a CBBC is the number of times the CBBC price will
change if the underlying asset price changes by 1%.
On the other hand, the conversion ratio of CBBC determines the sensitivity of the price of CBBC in
response to the price movement of the underlying asset. It demonstrates how much the underlying asset
has to move in order to push the theoretical price of the CBBC up or down by one tick size. The
mathematical formula is set out below for reference:
In accordance with the formula above, a lower conversion ratio means that a smaller price movement of
the underlying asset is required to push the theoretical price of the CBBC up or down by one tick size.
Assuming the conversion ratio of an index CBBC is 12,000:1 and its price is below HKD 0.250, then one tick
size will be HKD 0.001. According to the above formula (0.001 x 12,000 = 12), every 12 points of movement
in the index will push such CBBC up or down by HKD 0.001.
CONVERSION RATIO AND ITS RELATIONSHIP WITH SENSITIVITY
11
Price movement of the underlying
asset required to move the price of
CBBC by one tick size
The lowest trading spread
of CBBCConversion ratio= x
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Hong Kong Stock Exchange assigns each CBBC with a unique name containing a five-digit number and
certain notations. The table below sets out an example to illustrate what the notations and numbers in a
CBBC name stand for.
CBBC name description: BC#HSIRC0912A
INTERPRETING THE NAME OF CBBC
2
Each Hong Kong listed CBBC can also be identified by its stock code, which normally is a 5-digit number.
BC
#
HSI
R
C
0912
A
The first two letters represent the issuer, in this case Barclays
# represents CBBC
This represents the underlying asset, such as HSI, HSCEI, HSBC etc
R represents Category R CBBC; N represents Category N CBBC
C represents Callable Bull Contract; P represents Callable Bear Contract
These four numbers represent the expiry date, starting with the year followed by the
month, in this case December 2009
The alphabet represents the issue number with the same underlying asset and expiry
year and month, first one is A, second one is B, and so on
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Both CBBC and warrants are derivative investment products listed on the Hong Kong Stock Exchange and
both have gearing effects. Some investors may be confused due to certain similarities between these two
products. The following table highlights the differences between these two products:
COMPARISON BETWEEN CBBC AND WARRANTS
13
Underlying asset
Trading method
Taking bullish view
Taking bearish view
Exercise price
Call price
Mandatory call mechanism
Impact of implied volatility
Expiry date
Holding cost
Maximum loss
CBBC Warrants
Index, stock, commodity,
currency
Through normal
broker account
Callable Bull Contract
Callable Bear Contract
Yes
Yes
When the price of
the underlying asset
reaches the call price
Minimal
Yes
Funding costs will be
deducted daily from the price
of the CBBC
Initial investment
Index, stock, commodity,
currency
Through normal
broker account
Call warrant
Put warrant
Yes
No
No
High
Yes
Time value will decrease
gradually as the warrant
approaches expiry
Initial investment
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If a CBBC is not called before the expiry, the last trading day of the CBBC would be the trading day prior to
the expiry date. Investors need to be aware of the final trading date to buy-in or pull-out of their investment
in CBBC.
For investors who hold the CBBC until expiry, the profit and loss will depend on the settlement conditions.
If the closing price is above the exercise price of a Callable Bull Contract or below the exercise price of a
Callable Bear Contract, the investors will receive a cash settlement amount.
The method of calculating the closing price for index CBBC and stock CBBC is different. The closing price of
stock CBBC is based on the closing price of the underlying asset on the last trading day. On the other
hand, the calculation of the closing price of index CBBC is based on the EAS (as defined below) of the last
trading day of the relevant same month expiry index futures contract (usually the same day as the expiry
date of the index CBBC). EAS means the 5-minute average price of the spot index.
CBBC SETTLEMENT PROCEDURE
4
Lasting trading day
Index CBBC Stock CBBC
Closing price
One trading day prior to
the expiry date
5-minute average of the spot index
level (EAS) on the expiry date
One trading day prior to
the expiry date
The closing price on the last
trading day
The following table summarizes the cash settlement procedure of CBBC:
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Investors should carefully study the relevant listing documents and understand the risks involved prior to
investing in CBBC. CBBC are often seen as high risk investment products, mainly due to the gearing effect
which could magnify the potential return as well as the potential loss. Prices of CBBC may also fluctuate
significantly. Investors should consider the risks that they can tolerate make their own risk assessment
and seek professional advice where necessary before making an investment decision in CBBC. For
investors not involved in margin financing, the maximum loss of a CBBC investment is the loss of their
initial investment principal. The following highlights some (but not all) of the risks associated with
investing in CBBC. Investors should refer to base listing document and supplemental listing document for
comprehensive risk disclosures.
Inaccurate market forecast:
The CBBC price is mainly affected by the underlying asset price. Inaccurate judgments on the underlying
asset price movements are the most common causes of loss suffered by CBBC investors.
Mandatory call event:
CBBC have a mandatory call feature. CBBC will be terminated immediately when the spot price/level of the
underlying asset reaches the call price/level before the expiry date, regardless if the underlying asset price
rebounds within a short time after the occurrence of the mandatory call event. In such circumstances,
investors will or are likely to suffer significant losses and may lose their entire invested principal. In respect
of Category N CBBC, investors will not receive any cash payment after a mandatory call event occurs. Inrespect of Category R CBBC, investors may receive cash payment of the residual value. However, the
residual value would be lower than the price investors paid for purchasing the CBBC. In certain
circumstances, the residual value could be zero and the investor will lose the entire investment principal.
Investors should also note that during a volatile market when the underlying asset price is experiencing
extreme price movements, there is a higher chance that the mandatory call event of a CBBC may be
triggered.
Market demand and supply:It should be noted that CBBC are traded on a stock exchange where the price of CBBC is often dependent
on the supply and demand of the market. If a specific CBBC is popular in the market, the demand may
drive up the price of the CBBC, causing a deviation to its theoretical value. If the demand for such CBBC
decreases, or there is a strong selling pressure in the market, the CBBC price could fall below its theoretical
value. Investors should also note that the CBBC issuer acting through its appointed liquidity provider may
be the only market participant in respect of the relevant CBBC and the secondary market for such CBBC
may be limited.
INVESTMENT RISKS OF CBBC
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When choosing a CBBC, investors may consider following the five steps below according to their views, risk
tolerance levels and financial situations:
FIVE STEPS TO CHOOSE A CBBC
Underlying Asset
Callable Bull Contract or Callable Bear Contract
Call Price, Category R or N
Exercise Price and Conversion Ratio
Expiry Date
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