cbbc guide eng a4version final 19 feb 2010 (web)

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CALLABLE BULL/BEARCONTRACTS (CBBC) GUIDE

CBBC

Trade fast, trade up.

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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

18



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:

6



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)



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%



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



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



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



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:



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

15



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

17

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