University of Hong Kong Trading Workshop

1. University of Hong Kong Trading Workshop Class 11 Equity Workshop III Equities Derivatives David Lo

2. Agenda • Option Basics • Equity-linked Notes • Warrants • Guarantee Notes

3. Option Basics • Call & Put Options Spot Maturity Volatility Strike Price Interest Rate

4. Option Basics • Option Volatility (EquityOptionCalculator) -Rate of change in the underlying and the magnitude of these changes • Historical Volatility • Implied Volatility

5. Simple Option Strategies • Examples of option strategies • Covered Call, Spread, Straddle, Strangle. • Option Strategies using EquityOptionList.xls and EquityOptionStrategy.xls

6. Equity Option List Model

7. 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 = +

8. 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

9. 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?

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

11. ELN Calculator

12. ELN Calculator

13. 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

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

15. 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)

16. 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

17. 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.

18. 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.

19. 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

20. 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.

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

22. 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.

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

24. 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

25. Guaranteed Notes Calculator

26. Q & A DAVID_HKU@YAHOO.COM