Derivatives and Structured Products
Derivatives questions test product mechanics as much as regulation: what is exchange-traded, what is over-the-counter, how structured products work, and what must be disclosed before a client trades.
Exchange-traded and OTC markets
- HKFE lists futures and options; SEHK lists stock options, derivative warrants and callable bull/bear contracts; HKCC and SEOCH clear the relevant contracts.
- The OTC derivatives regime introduced Type 11 (dealing in or advising on OTC derivative products) and Type 12 (client clearing) licences.
- Mandatory reporting to the HKTR and mandatory clearing apply to prescribed standardised transactions.
- Large open positions in specified contracts must be reported under the Contracts Limits and Reportable Positions Rules.
Structured products
- Listed derivative warrants and callable bull/bear contracts are issued under the structured product chapter of the Listing Rules and need an SFC-authorised listing document.
- Unlisted structured products sold to retail need SFC authorisation under the SFO.
- Suitability, product due diligence and risk disclosure apply with particular force to complex products.
Client protection
- A risk disclosure statement must be explained and signed before derivatives trading.
- Margin financing is a separate regulated activity (Type 8).
- Issuer credit risk in a warrant or callable bull/bear contract sits with the issuer, not HKEX.
Worked example
An investor buys a bull callable bull/bear contract with a strike of HK$100 and a call price of HK$105, ratio one share per contract. The underlying rises to HK$105, triggering a mandatory call event; trading stops. At settlement the underlying is HK$106. The contract is not worthless: the residual value is HK$106 minus HK$100, or HK$6 per contract. Had settlement been at or below HK$100, the residual would be zero.
Traps
- Confusing the call price with the strike; the call price is the trigger, the strike drives residual value.
- Assuming a mandatory call wipes out all value.
- Thinking HKEX guarantees the issuer's obligations.
- Treating a signed risk disclosure statement as proof of suitability.