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CBBC
What are CBBCs?

Callable Bull/Bear Contracts which are also known as CBBCs are issued either as Bull or Bear contracts with a fixed expiry date. The lifespan of CBBCs can be ranged from 3 months to 5 years. CBBCs have a feature to track the performance of an underlying asset without requiring investors to pay the full price required to own the actual asset. Investors may trade on the market freely before the expiry date but if the call price of the CBBC is reached before expiry, the CBBC will expire early and the trading of that CBBC will be terminated immediately. The specified expiry date from the listing document will no longer be valid.

Features of CBBCs:
CBBC price moves tend to track the price moves of the underlying assets closelyThe price of a CBBC tends to follow closely the price of the underlying assets (ie delta close to one).Thus, if the underlying assets increase in value, a Bull CBBC with entitlement ratio of 1 to 1 generally increases in value by approximately the same amount, whereas a Bear CBBC with entitlement ratio of 1 to 1 generally decreases in value by approximately the same amount. However, when the underlying assets of a CBBC are trading at a price close to its Call Price, the value of CBBC may become more volatile and the change in its value may be disproportionate to the change in the value of the underlying assets.
CBBC have a Call Price and a mandatory call featureFor Bull contracts, the Call Price must be either equal to or above the strike price. For Bear contracts, the Call Price must be equal to or below the strike price. If the underlying assets’ price reaches the Call Price at any time prior to expiry, the CBBC will expire early. The issuer must then call the CBBC and trading of the CBBC will be terminated immediately. Such an event is referred to as a mandatory call event(“MCE”).
Category N CBBC and Category R CBBCA Category N CBBC refers to a CBBC where its Call Price is equal to its strike price, and the CBBC holder will not receive any cash payment once the price of the underlying assets reach or go beyond the Call Price. ? A Category R CBBC refers to a CBBC where its Call Price is different from its strike price, and the CBBC holder may receive a small cash payment (called "residual value") upon the occurrence of an MCE but in the worst case, no residual value will be paid (Category N CBBC do not have residue value).
Difference between CBBCS and Warrants:

CBBCsWarrants
Response to price change in underlying assetChanges in value by approximately the same amount as the underlying assetIn addition to underlying asset price, must also consider the exercise price, interest rate, tenor, implied volatility, etc
Implied volatilityInsignificant to trading price of CBBCsAffects trading price of Warrants
Funding costsSpecified in the listing documenBuilt into the premium price of a warrant
Tenor3 months to 5 years6 months to 5 years
Mandatory callTerminated early when the price of the underlying asset hits the call priceNo mandatory call feature
Closing priceHK Stock:The closing price on the expiry dateHK Stock:The average of the closing prices of the underlying stock quoted on each of the 5 business days falling immediately before the expiry date of a warrant
How do CBBCs work:

Since most of the CBBCs listed in Hong Kong belong to the “Category R” (may have residual value), we will simply explain the basic operation of the CBBCs with a “Category R” bull contract and a “Category R” bear contract. Example - “Category R” bull contract.

Underlying assetStock AContract Entitlemen8%
Spot Price$110Funding costs$7.2
Call Price$95Exchange Ratio100
Strike Price$95Tenor12 months
Theoretical price of Bull Contract at issue(Spot - Strike + Funding costs) / Contract Entitlement:(110 - 90 + 7.2) / 100 = $0.272
Share per lot10,000Value of one board lot$2,720

Scenario 1

The call price has not yet been reached. The closing price on the expiry date is $120

Investor will receive (per share)

= (Closing Price - Strike Price)/Exchange Ratio

= ( 120 - 90 ) / 100

= $0.3

Scenario 2

Reach the Call Price. If Spot Price falls to $95

Investor will receive (per share)

= (Closing Price - Strike Price)/ Exchange Ratio

= ( 95 - 90 ) / 100

= $0.05

Example - “Category R” bear contract
Underlying assetStock BContract Entitlement8%
Spot Price$110Funding costs$11.2
Call Price$130Exchange Ratio100
Strike Price$140Tenor12 months
Theoretical price of Bull Contract at issue(Spot - Strike + Funding costs) / Contract Entitlement( 140 – 110 + 11.2) / 100 = $0.312
Share per lot10,000Value of one board lot$3,120

Scenario 1

The call price has not yet been reached. The closing price on the expiry date$120

Investor will receive (per share)

= (Strike Price - Closing Price)/ Exchange Ratio

= ( 140 - 120 ) / 100

= $0.2

Scenario 2

Reach the Call Price. If Spot Price rises to $135

Investor will receive (per share)

= (Strike Price - Closing Price)/ Exchange Ratio

= ( 140 - 130 ) / 100

= $0.05

Factors affecting the price of CBBCs:
Factors affecting the price of CBBCsbull contractbear contract
price of underlying assets+-
funding costa++
dividend of underlying assets-+
How to choose a CBBC:
1. Funding costs

The calculation of funding costs varies from issuer to issuer. The issuers may have different calculation methods and may use different prime interest rate.You should read its prospectus /listing documents in its entirety before you decide to invest.

When choosing between CBBCs with similar underlying assets and features, you should choose the one with lower funding costs.

2. Leverage Effect

The farther the difference between the price of the underlying asset and the call price, the lower the leverage; the longer the tenor of a CBBC, the lower the leverage.

You should carefully consider your view on the relevant stock, your risk tolerance level and your financial plan prior to making any choice of tenor and call price of a CBBC.

Risks of CBBCs:
Mandatory callA CBBC will be called by the issuer when the price of the underlying assets hits the Call Price, and that CBBC will expire early.The payoff for Category N CBBC is zero when they expire early.When Category R CBBC expire early the holder may receive a small residual value payment, but there may be no residual value payment in some situations.Dealers may charge their clients a service fee for the collection of the residual value payment from the respective issuers.
Limited lifeA CBBC has a limited lifespan, as denoted by the fixed expiry date, of three months to five years.The life of a CBBC may be shorter if called before the fixed expiry date.The price of a CBBC fluctuates with the changes in the price of the underlying assets.A CBBC may become worthless after expiry or if the CBBC has been called early.
Funding costsWhen a CBBC is called, the CBBC holders will lose the funding cost for the full period, since the funding cost is built into the CBBC price upfront at launch, even though the actual period of funding for the CBBC turns out to be shorter when there is an MCE.In any case, investors should note that the funding costs of a CBBC after launch may vary during its life and the liquidity provider is not obliged to provide a quote for the CBBC based on the theoretical calculation of the funding costs for that CBBC at launch.。
Leverage effectSince a CBBC is a leveraged product, the percentage change in its price is greater compared with that of its underlying assets.Its leverage ratio may vary during the lifespan.
LiquidityAlthough CBBC have liquidity providers, there is no guarantee that investors will be able to buy/sell CBBC at their target prices any time they wish.

Please refer to the link below for Disclaimer of the above information.

(http://www.bocionline.com/en/home/disclaimer/index.shtml)

This article was written by BOCI's equity derivatives team - BOCI Equity Derivatives Department.