A CBBC is an instrument that tracks the performance of an underlying asset. The trading price of a CBBC tends to mirror the movement in the price of its underlying asset. Like standard warrants, CBBCs can be issued over a range of eligible underlying assets prescribed by the Exchange from time to time. However the scope of eligible underlying assets is currently more restrictive for CBBCs than it is for standard warrants. The list of eligible stocks for CBBCs is posted on the HKEX’s website. A CBBC can be issued as a bull contract or a bear contract. A “bull” CBBC may be invested in by an investor who holds a view that the price of the underlying asset will increase during the term of the CBBC. A “bear” CBBC may be invested in by an investor who holds a view that the price of the underlying asset will decrease during the term of the CBBC. Similar to a standard warrant, a CBBC may provide a leveraged return, but also carries the risk of magnifying your losses. Your maximum loss under a CBBC is limited to the investment amount you pay for the CBBC (plus any transaction costs, such as broker fees associated with your investment).

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General features of standard warrants, inline warrants and CBBCs

1.1 What are standard warrants?

A standard warrant is an instrument that gives the holder a right – but not the obligation - to “buy” or “sell” an underlying asset at a pre-set price (called the “exercise price”) on or before the expiry date. Standard warrants can be issued over a range of assets, including but not limited to stocks, exchange traded funds, stock indices, currencies and commodities or a basket of assets. The list of eligible stocks for warrants over single stock is posted on the HKEX’s website. However, investing in a standard warrant does not give you any rights in or to the underlying asset. Currently, all standard warrants are cash settled when exercised on expiry.

There are two types of standard warrants:

A “call” warrant may be invested in by an investor who believes that the price of the underlying asset will increase during the term of the standard warrant.
A “put” warrant may be invested in by an investor who believes that the price of the underlying asset will decrease during the term of the standard warrant.

Typically, standard warrants in Hong Kong are issued with a life span of six months to two years, but are usually traded by investors before expiry. Standard warrants magnify your investment through leverage. This carries significant opportunities as well as significant risks. Standard warrants usually cost a fraction of the price of the underlying asset and may provide a leveraged return, but such leverage could also magnify your losses.

Standard warrants are a special form of option in which an investor can only take a long position in the standard warrants, just like option buyers. This means you can only take a long position in a call or a put warrant by buying such standard warrant and close out such long position previously established by selling such standard warrant – that is, you cannot short sell such standard warrant.

Your maximum loss will therefore be limited to the amount you pay for the standard warrant (plus any transaction costs, such as broker fees associated with your investment).

1.2 How do standard warrants work?

This depends on the type of warrant you buy (call versus put). The following examples deal with either a call or put warrant linked to a local stock.

Call warrant

At the expiry of a call warrant over a local stock, if the 5-day average closing price of the underlying stock before the expiry date is:

higher than the warrant’s exercise price, the warrant is “in-the-money” and will be exercised automatically at expiry. In that case, you will receive a cash payment calculated by reference to the positive difference between that 5-day average closing price and the exercise price of the call warrant, adjusted by the entitlement ratio; or
equal to or lower than its exercise price, the warrant is “at-the-money” or “out-of-the-money”, respectively, and will become worthless.

Put warrant

At the expiry of a put warrant over a local stock, if the 5-day average closing price of the underlying stock before the expiry date is:

lower than its exercise price, the warrant is “in-the-money” and will be exercised automatically at expiry. In that case, you will receive a cash payment calculated by reference to the positive difference between the exercise price and that 5-day average closing price, adjusted by the entitlement ratio; or
equal to or higher than its exercise price, the warrant is “at-the-money” or “out-of-the-money”, respectively, and will become worthless.

1.3 How are the rights of a standard warrant holder different from the rights of a shareholder over the underlying stock?

Holder of a standard warrant on an underlying stock does not have the same rights as the shareholder of the underlying stock. Holders of standard warrants do not have voting rights or the right to receive any dividends, bonus or other distributions from the issuer of the underlying stock. The life span of a standard warrant is fixed, which may be automatically exercised on its expiry date or may expire worthless, whereas a shareholder of the underlying stock can hold such stock as a long term investment.

1.4 What are inline warrants?

An inline warrant is an instrument that entitles its holder to receive a fixed pre-determined amount which depends on whether the level of an underlying asset is at or falls within (“in-the-range”) or outside (“out-of-the-range”) the upper and lower strike prices or levels at expiry. Inline warrants can be issued over a range of assets, including stocks and stock indices. Like standard warrants, inline warrants can be issued over a range of eligible underlying assets prescribed by the Exchange from time to time. However the list of eligible underlying assets is currently more restrictive for inline warrants than it is for standard warrants. The list of eligible underlying assets for inline warrants is posted on the HKEX’s website.

Investing in an inline warrant does not give you any rights in or to the underlying asset and currently, all inline warrants are cash settled when exercised on expiry.

When an inline warrant is in-the-range at expiry, the amount payable per inline warrant is HK$1. When an inline warrant is out-of-the-range at expiry, the amount payable per inline warrant is HK$0.25.

Unlike standard warrants which provide a directional (i.e. upwards or downwards) exposure, investors in inline warrants would expect markets to remain flat or within a range.

In addition, as the payout of an inline warrant is capped at a fixed amount of HK$1 per inline warrant, it is usually traded at a price which is lower than the maximum payout of HK$1. Therefore, any trade on inline warrants conducted above HK$1 will be cancelled automatically by the Exchange.

Investors can only take a long position in an inline warrant by buying such inline warrant and close out such long position previously established by selling such inline warrant, you cannot short sell an inline warrant.

If you hold an inline warrant which expires out-of-the-range, your maximum loss will be limited to the amount you pay for the inline warrant less the pre-determined fixed payoff at expiry (i.e. HK$0.25 per inline warrant) (plus any transaction costs, such as broker fees associated with your investment).

In the case that issuers become insolvent or default on their obligations under the inline warrants or their guarantors become insolvent or default on their obligations under the guarantee, the maximum loss in the inline warrants will be your entire investment amount plus any transaction costs.

1.5 How do inline warrants work?

The payout of an inline warrant at expiry will depend on whether such inline warrant is in-the-range or out-of-the-range at expiry.

An inline warrant will be in-the-range at expiry when the valuation at expiry of the underlying asset is at or falls within the upper and lower strike prices or levels.

An inline warrant will be out-of-the-range at expiry when the valuation at expiry of the underlying asset falls outside the range determined by the upper and lower strike prices or levels.

The potential payoff at expiry for inline warrants are based on two possible scenarios:

Scenario one - When an inline warrant is in-the-range at expiry, then its holder is entitled to receive a cash settlement amount equal to HK$1 per inline warrant.
Scenario two - When an inline warrant is out-of-the-range at expiry, then its holder is entitled to receive a cash settlement amount equal to HK$0.25 per inline warrant. This is because this cash settlement amount of HK$0.25 is incorporated in the price (i.e. paid upfront) when purchasing an inline warrant.

Therefore an investor in an inline warrant will expect the valuation at expiry of the underlying asset to fall within or at the upper and lower strike prices or levels at expiry.

The valuation at expiry will be determined as follows:

with respect to an index underlying: the final settlement price of the underlying index on expiry day; or
with respect to a stock underlying: the average of the closing prices of the underlying stock for five trading days immediately preceding expiry day.

1.6 How are the rights of an inline warrant holder different from the rights of a shareholder over the underlying stock?

A holder of an inline warrant on an underlying stock does not have the same rights as the shareholder of the underlying stock. Holders of inline warrants do not have voting rights or the right to receive any dividends, bonus or other distributions from the issuer of the underlying stock. The life span of an inline warrant is fixed, whereas a shareholder of the underlying stock can hold such stock as a long term investment.

In addition, the payout of an inline warrant economically differs from a levered exposure to the underlying stock as an inline warrant can only either pay a fixed amount at expiry: HK$1 per inline warrant when in-the-range or HK$0.25 when out-of-the-range. Holders of inline warrants do not benefit from unlimited upside on the underlying stock.

1.7 What are exotic warrants? What are the differences between an exotic warrant and a standard warrant?

There are various types of warrants in the market. Exotic warrants carry exotic features and their terms may be more complicated than standard warrants. An exotic warrant is usually identified with an “X” in its English stock short name. For more details, investors should refer to the listing documents and seek independent professional advice.

Inline warrant is one kind of exotic warrants, it is identified with an “L” in its English stock short name.

1.8 What are CBBCs?

A CBBC is an instrument that tracks the performance of an underlying asset. The trading price of a CBBC tends to mirror the movement in the price of its underlying asset. Like standard warrants, CBBCs can be issued over a range of eligible underlying assets prescribed by the Exchange from time to time. However the scope of eligible underlying assets is currently more restrictive for CBBCs than it is for standard warrants. The list of eligible stocks for CBBCs is posted on the HKEX’s website.

A CBBC can be issued as a bull contract or a bear contract.

A “bull” CBBC may be invested in by an investor who holds a view that the price of the underlying asset will increase during the term of the CBBC.
A “bear” CBBC may be invested in by an investor who holds a view that the price of the underlying asset will decrease during the term of the CBBC.

Similar to a standard warrant, a CBBC may provide a leveraged return, but also carries the risk of magnifying your losses. Your maximum loss under a CBBC is limited to the investment amount you pay for the CBBC (plus any transaction costs, such as broker fees associated with your investment).

1.9 How do CBBCs work?

A CBBC is generally issued at a price that represents the difference between the spot price or level of the underlying asset and the strike price or level of the CBBC, plus the issuer’s funding costs.

CBBCs have a mandatory call feature measured by reference to a call price or level. If the spot price or level of the underlying asset is at or below (in respect of a series of bull CBBCs) or at or above (in respect of a series of bear CBBCs) the call price or level at any time during an observation period (including pre-opening session, continuous trading session and closing auction session), a mandatory call event is triggered, following which the CBBC is terminated early and the trading of that CBBC ceases immediately. Otherwise, the following happens on expiry:

Bull CBBCs

For a bull CBBC, if the closing price or level of the underlying asset at expiry is:

higher than the CBBC’s strike price or level, you will receive a cash payment calculated by reference to the positive difference between that closing price or level and the strike price or level of the CBBC, adjusted by the entitlement ratio; or
equal to or lower than its strike price or level, the CBBC will become worthless.

Bear CBBCs

For a bear CBBC, if the closing price or level of the underlying asset at expiry is:

lower than the CBBC’s strike price or level, you will receive a cash payment calculated by reference to the positive difference between strike price or level of the CBBC and that closing price or level, adjusted by the entitlement ratio; or
equal to or higher than its strike price or level, the CBBC will become worthless.

1.10 What are the differences between standard warrants, inline warrants and CBBCs?

The following table describes the key differences between standard warrants, inline warrants and CBBCs.

Feature	Standard Warrants	Inline Warrants	CBBCs
Response to price movement in underlying asset	The value is expected to increase when the likelihood of the underlying asset being in-the-money (above the strike price or level for a call warrant or below the strike price or level for a put warrant) at expiry increases. Conversely, the value is expected to decrease when the likelihood of the underlying asset being out-of-the-money (below the strike price or level for a call warrant or above the strike price or level for a put warrant) at expiry increases.	The value is expected to increase when the likelihood of the underlying asset being within or at the upper and lower strike prices or levels at expiry increases. Conversely, the value is expected to decrease when the likelihood of the underlying asset being within or at the upper and lower strike prices or levels at expiry decreases.	The value is expected to change by approximately the same amount as the underlying asset, but still depends on various factors.
Implied volatility	Affects trading price	Affects trading price	Insignificant to trading price
Tenor	6 months to 5 years	6 months to 5 years	3 months to 5 years
Strike	One strike	Two strikes	One strike
Time value	Time value decreases over time	Time value decreases when the underlying price or level is out-of-the-range; time value increases when the underlying price or level is in-the-range.	Time value decreases over time (reflected in funding cost)
Payoff at expiry	Variable depending on the settlement price versus the strike price	Fixed pre-determined payout, depending on the settlement price or level vs. the upper and lower strike prices or levels	Variable depending on the settlement price versus the strike price
Mandatory call	No mandatory call feature	No mandatory call feature	Has mandatory call feature. A CBBC is terminated prior to expiry day when the price of the underlying asset hits the call price
Underlying assets	More underlying assets are eligible for issuance	Relatively fewer underlying assets are eligible for issuance	Relatively fewer underlying assets are eligible for issuance

1.11 What is the difference between a “Category R” and a “Category N” CBBC?

The difference between these two categories of CBBCs is where the call price or level of the CBBC is set.

A “Category N” CBBC refers to a CBBC where its call price or level is equal to its strike price or level, under which you will not receive any cash payment after the occurrence of a mandatory call event and will lose your entire investment.
A “Category R” CBBC refers to a CBBC where its call price or level is different from its strike price or level, and you may receive a residual cash payment (called “residual value”) upon the occurrence of a mandatory call event. However, in the worst case, you will not receive any residual value and will lose your entire investment.

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