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University of Hong KongUniversity of Hong Kong

Trading WorkshopTrading Workshop

David Lo

Class 11Class 11

Equity Workshop IIIEquity Workshop III

Equities DerivativesEquities Derivatives

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Agenda

• Option Basics

• Equity-linked Notes

• Warrants

• Guarantee Notes

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Option Basics

• Call & Put Options

Volatility

Maturity

Spot

Interest Rate

Strike Price

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Option Basics

• Option Volatility (EquityOptionCalculator)

-Rate of change in the underlying and the magnitude of these changes

Historical Volatility

Implied Volatility

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Simple Option Strategies

• Examples of option strategies

Covered Call, Spread, Straddle, Strangle.

• Option Strategies using EquityOptionList.xls and EquityOptionStrategy.xls

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Equity Option List Model

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Equity-linked notes (ELN)

• ELN is a combination of a short or medium note with an option position

- Yield enhancement

- Note/deposit + short option(s)

- Bull ELN, Bear ELN, Strangle ELN

• Bull ELN is the most popular type, over 90% ELN trades are Bull ELN

ELN

USD 10,000

Yield: 24%

Time Deposit

USD 10,000

Yield: 2%

Short a asset Put option struck at strike price

Premium received is packaged as extra yield

= +

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ELN

• Investor can choose a stock he/she is willing to acquire at a price lower than current market level =>Put Strike Price

• Usually set at 5 to 10% below current price

• Then the investor can choose a maturity

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Fair Yield of an ELN

• How can we know whether an ELN is giving a fair yield? Or the participation rate is fair for a capital guarantee note?

• The answer lies on the price of the option:

- Are we getting fair price for selling option(s) or paying fair price for buying option(s)?

- Whether an option is fairly priced or not can be judged from the implied volatility of the option?

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Example of ELN

Issuer: ABC Investment Underlying Stock: HSBC Holdings plc <0005.HK> Underlying Price: HK$85Put Strike Price: 90% of Spot, or $77.18Trade Price: 99.05%Trade Date: 10-Oct-02Settlement Date: 24-Oct-02Valuation Date: 12-Nov-02Maturity Date: 14-Nov-02Denomination: HK$100,000Shares per Note: 1296 ( subject to adjustment)

ELN Calculator.xls

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ELN Calculator

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ELN Calculator

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Warrants in HK

• How to find the best warrants for your clients?

• Based on their requirements :

• - Top 5 turnover

• - Maturity < Jun 2005

• - Cheaper (Implied Volatlity)

• - Call

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Example of 0941.HK (China Mobile) - 0941W.HK (F3)

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Agenda

• HKEx traded warrants: Equity and Derivative warrants

• How to search Quotes & News for Warrants

• Interpretation of Volatility, Implied Volatility, Delta, Gearing and e-Gearing

• Features and Benefits of the Hong Kong Warrants Model under Reuters 3000 Xtra

• How to download Warrants Data into Excel (PPP)

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Types of Warrants

• Warrants are listed on the Stock Exchange of Hong Kong, and Hong Kong Exchanges and Clearing Limited (HKEx).

• Two kinds of warrants: equity and derivative warrants

• http://www.hkex.com.hk/invedu/booklet/dwflyer.pdf

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Equity Warrants

• Give their holders the right to subscribe for equity securities of an issuer at a predetermined price.

• Are issued by that issuer or any of its subsidiaries.

• Can be either American or European style.

• Must have a minimum life from one year and up to maximum of five years from the date of issue or grant.

• The issuer of the warrants is obliged to deliver the underlying securities upon full payment of the exercise price by the warrant holder.

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Derivative Warrants

• Fall under the category of derivative investment instruments.

• Have a minimum life of six months from the date of issue or grant and a maximum life of five years (normally from six months to two years.

• The underlying assets of derivative warrants can be ordinary shares, market indices, foreign currencies, commodities or a basket of shares. The issuer of derivative warrants may not be the issuer of the underlying assets, but should hold or have a right to hold the underlying assets.

• Are issued by a third party, generally an investment bank, independent of the issuer of the underlying assets and its subsidiaries.

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Exercising Derivative Warrants

• Investors may receive the underlying assets or an equivalent amount of cash.

• The issue and exercise of derivative warrants has no effect on the quantity of the underlying assets (such as ordinary shares).

• They provide the market with instruments which may be used for hedging or investment purposes

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Hong Kong Warrants Model

• Allows you to have an easy navigation through the various display of the warrants and their instruments.

• Has a general overview of the index constituents and the ranking statistics of the stocks and their warrants

• Analyses the stock and its constituent warrants.

• Views the relative performance of a warrant against its underlying and to analyze them technically

• Tracks a list of ten stocks based on the total trading volume of their warrants on a real time basis.

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Hong Kong Warrants ModelStock Overview• A quick overview of the stock market and performances

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Hong Kong Warrants Overview

• It narrows to the warrants data, with the Sub-heading of Top – Volume, Net Gainers, Net Losers, % Gainers, % Losers, Top Value, Market Digest and All Warrants.

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Derivative Warrants (I)(Code: 0005.HK)

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Guaranteed Notes

• The main features of a capital guarantee note is

- Principal protection (capital guarantee), and

- Participation of equity market performance

• Linked to

- Single stock

- Basket of stocks

- Stock market index, sub-index

- Basket of stock market indexes

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Guaranteed Notes Calculator

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Q & A

DAVID_HKU@YAHOO.COM