Callable Bull/Bear Contract
1. What is a CBBC?
The CBBC is an emerging hot investment tool in recent years. Similar to the warrant, it is also subject to terms such as strike price, expiry date and entitlement ratio. The CBBC is similar to the futures index trading. The financial costs of CBBC arise from the payment made by the investors for borrowing money from the issuer to buy/sell related assets, and to obtain the gearing effect.
By investing in a callable bull contract, investors are bullish on the prospect of the underlying asset and intend to capture its potential price appreciation. Conversely, investors buying a callable bear contract are bearish on the prospect of the underlying asset and try to make a profit in a falling market, which are similar to the case of call warrant and put warrant.
The difference between the warrant and CBBC lies that CBBC features a mandatory call mechanism. When the price of underlying asset touches the call price of CBBC, a Mandatory Call Event will take place to the CBBC.
Investors do not need to cover short position. The loss is capped by the initial investment in the purchase of CBBC.
Identification of CBBC:
At the beginning of launching CBBC, many investors failed to distinguish between the warrant and CBBC, and some investors knew that CBBC was bought, instead of a warrant after a Mandatory Call Event took place to the CBBC.
It is easy to identify the CBBC from three aspects.
(1) Pay attention to whether the derivative product has a call price, as only the CBBC has a call price in the market.
(2) Pay attention to whether there are the words of “牛”(bull) or “熊”(bear) contained in the Chinese name of CBBC.
(3) Telephone the issuer for enquiry
2. Difference between the warrant and CBBC
All CBBCs are in-the-price products with a Delta of approximately 1 (Delta One Product). The CBBC is similar to the warrant, and is also affected by factors such as the price of the underlying assets, strike price, expiry date, dividend, and interest rate.
In the real market, the strike price and expiry date of the CBBC have been determined prior to listing and will not change during the listing period (except for the adjustment of strike price due to the ex-warrants or distribution of incentive shares).
The main differences between CBBC and warrant lie in:
(1) Benefiting from long deep in-the-money feature, CBBC is theoretically less affected by the implied volatility, not as the warrants;
(2) CBBC possesses a feature that it has a Delta approximately equal to 1, so that it is easier to understand the relationship between CBBC and the underlying asset price, compared with the warrant;
(3) The time value loss of CBBC is also close to linear, that is, the reduction speed of the time value approaching the expiry date is not as fast as the warrant.
3. Definitions in relation to CBBC
(1) Call price
CBBC features a mandatory call mechanism. When the underlying asset price of the CBBC touches the call price before the CBBC expires, the CBBC trading will be suspended, a Mandatory Call Event will take place to the CBBC, and CBBC will be settled.
When the underlying asset price of the CBBC is close to the call price, the price fluctuation of the CBBC may be higher than its theoretical variation.
When a Mandatory Call Even takes place to the CBBC, trading of the CBBC will not be resumed, even if the underlying asset price is higher (Bull Contract) or lower (Bear Contract) than call price. The call price has been established at the time of the listing of the CBBC and is generally displayed on the quotation machine and product terms.
(2) Gap percentage of call
It refers to the percentage of gap between the CBBC call price and ruling price of the underlying asset. If there is a small gap percentage, the price of the called CBBC is close to the ruling price of the underlying asset; if there is a large gap percentage, the price of the called CBBC is far from the ruling price of the underlying asset. However, this percentage does not fully reflect the risk of CBBC call, as market volatility may change from time to time. In a market with a large volatility, CBBC may be called, although the gap percentage of ruling price of the underlying assets is as high as 10% from the call price. Therefore, the CBBC investors should also take into account the volatility of the market.
(3) Strike price
If the CBBC is held until expiration and not called, the CBBC Investor can conceptually call (Bull Contract)/ put (Bear Contract) the underlying assets by the strike price. In the actual trading of the CBBC, the amounts will be returned to the investor upon settlement in cash. The strike price has been established when the CBBC is listed and will generally be displayed on the quotation machine and product terms. The call price and strike price of the Bull Contract subject to pit trading are unlikely to be higher than the ruling price of the underlying asset; the call price and the strike price of the Bear Contract are unlikely to be lower than the ruling price of the underlying asset, as these “out-of-the-money” CBBCs should have been called. In theory, all CBBCs subject to pit trading are “in-the-money”.
(4) Entitlement ratio
The entitlement ratio of stock CBBC is generally 1, 10 or 100; the entitlement ratio of the index CBBC varies greatly, ranging from thousands to tens of thousands. The entitlement ratio has an impact on the face value of the CBBC and the price movement in the market on one day, but does not affect its theoretical price change. The smaller the entitlement ratio, the larger the face value of the CBBC, and the faster the price movement in the same price range.
It refers to the number of underlying assets required to be called/put at the time of hedge, when the issuer puts/calls a CBBC. Many investors believe that the Delta of the CBBC is about 1, but in fact the Delta of CBBC range from 0.6 to 1.4 as Delta of CBBC is affected by the dividend payout frequency and dividend payout ratio of the underlying assets before the expiry date of the CBBC.
Since the dividend payout of the underlying assets before the expiration will increase the expected strike value of Bear Contract and decrease the expected strike value of Bull Contract, in general, the longer the period of the Bull Contract, the smaller the Delta; and the longer the period of Bear Contract, the greater the Delta.
In addition, the Delta of CBBC will alter along with the change in the underlying asset price. The greater gap between the underlying asset price and CBBC strike price, that is, the deeper in-the-money the CBBC, the closer the Delta will be to 1; The closer the underlying asset price is to the CBBC call price, the more the Delta will fluctuate. Therefore, investors should check the Delta and adjust the investment strategy according to market changes.
(6) Outstanding Quantity
Since the trading of the CBBC does not involve the over-the-counter option hedging, The outstanding quantity has a minor impact on the price performance of the CBBC. The issuer also actively repurchased the CBBC. Once the investor chooses to Call/put the CBBC widely at the same time, the CBBC may deviate from the theoretical price in a short period of time.
The CBBC premium means how much the underlying asset price of CBBC needs to rise/fall after the investor buys and holds the CBBC till the expiry date, so that the investor of CBBC can break even. The premium of the CBBC can also be understood as the actual value of the financial costs charged by the issuer against CBBC. If the investor holds the CBBC with a lower premium when a Mandatory Call Event takes place to the CBBC with the same call price but different expiry dates, he/he will surfer lesser financial expense loss than those who buy CBBC with a higher premium. However, if the investor holds a deep in-the-money CBBC for a long time, it is advisable to compare the annual ratio of financial expense of the CBBC subject to the similar terms.
The gearing of the CBBC is mostly very “actual” or “effective”. Since the Delta of the CBBC is quite close to 1, it is not necessary to add the Delta parameters when calculating the actual gearing. The gearing of the CBBC is equivalent to its actual gearing. The gearing change of CBBC conversed to the rise/fall of the underlying assets. If a Bull Contract rises due to an rise in the price of the underlying asset, the gearing of the CBBC will decrease; on the contrary, if a Bull Contract falls due to the fall in the price of the HIS underlying asset, the gearing of the CBBC will increase. Therefore, once the CBBC investors misjudge the direction, they need to check whether the gearing of the CBBC they hold will become too high and exceed the risk level they can afford. If so, the CBBC Investor should consider changing to another CBBC with lower gearing; investors who judge the right direction may consider changing to CBBC with a higher gearing, so as to maintain the original gearing.
4. CBBC settlement method
The last trading day of the CBBC refers to one trading day before the expiry date (different from the fourth trading days prior to the expiry date of the warrant).
Settlement value of Bull Contract = (settlement price - strike price) / entitlement ratio
Settlement value of Bear Contract = (strike price - settlement price) / entitlement ratio
Its settlement price is based on the EAS (expected average settlement price) published by the Hong Kong Exchanges and Clearing Limited (HKEX). EAS refers to the average price of relevant indexes every 5 minutes on the expiry date of the front-month futures indexes (the reference price is the same as the index warrant).
Its settlement price refers to the closing price of the underlying asset on the trading day prior to the expiry date of the CBBC (different from the settlement price of the stock warrant, which is based on the average closing price of 5 trading days prior to the expiry date of the shares).