Risk Disclosure Statement for Exchange-Traded Derivative Products

This Risk Disclosure Statement is intended as a general guide to highlight the trading risks of certain types of and derivative products.  We have endeavored to ensure the accuracy and reliability of the information provided but do not guarantee its accuracy and reliability and accept no liability for any loss or damage arising from any inaccuracies or omissions.  For more relevant information, investors may visit the websites of HKEx at www.hkex.com.hk and the SFC at www.sfc.hk. 

Risks Associated with Structured Products

1) Expiry considerations

Structured products have an expiry date after which the issue may become worthless.  Investors should be aware of the expiry time horizon and choose a product with an appropriate lifespan for their trading strategy.

2) Gearing risk

Structured   products, such   as   derivative   warrants   and   callable bull/bear contracts, are leveraged and their value could change rapidly according to the gearing ratio relative to the underlying assets. Investors should be aware that the value of structured products might fall to zero resulting in the total loss of their initial investment.

3) Extraordinary price movements

Outside influences such as market supply and demand factors may cause the price of a structured product to deviate from its theoretical price. As a result, actual traded prices can be higher or lower than the theoretical price.

4) Issuer default risk

A structured product issuer could become insolvent and default on there listed securities and in that event investors will be considered as unsecured creditors and will have no preferential claims to any assets held by the issuer. Investors should therefore pay close attention to the financial strength and credit worthiness of structured product issuers.

5) Uncollateralised product risk

Uncollateralised structured products are not asset backed.  In the event of the bankruptcy of the issuer, investors could lose their entire investment.

6) Foreign exchange risk

Underlying assets of structured products could be denominated in a currency different from an investor’s base currency. Hence, investors are exposed to exchange rate risk.  Currency rate fluctuations can adversely affect the value of the underlying asset of a structured product, thereby affecting the price of the structured product.

7) Liquidity risk

Liquidity providers assigned by structured product issuers provide two way quotes to facilitate trading of the products.  If a liquidity provider defaults or ceases to fulfill its role, investors may not be able to trade the relevant product until a new liquidity provider has been assigned.

 

Risks Involved in Trading Callable Bull/Bear Contracts (CBBC)

1) Mandatory call risk

Investors  trading  CBBCs  should  be  aware  of  their  intraday “knockout” or mandatory call feature. A CBBC will cease trading when the underlying asset value equals the mandatory Call Price as stated in the listing documents. Investors will only be entitled to the residual value of the terminated CBBCs as calculated by the product issuer in accordance with the listing documents, and the residual value can be zero. Once the CBBC is called, even though the underlying asset may bounce back in the right direction, the CBBC, which has been called, will not be revived and investors will not be able to profit from the bounce back. In general, the larger the buffer between the Call Price and the Spot Price of the underlying asset, the lower the probability of the CBBC being called since the underlying asset of that CBBC would have to experience a larger movement in the price before the CBBC will be called. However, at the same time, the larger the buffer, the lower the leverage effect will be.

2) Trading of CBBC close to Call Price

When the underlying asset is trading close to the Call Price, the price of a CBBC may be more volatile with wider spreads and uncertain liquidity. CBBC may be called at any time and trading will terminate as a result.  However, the trade inputted by the investor may still be executed and confirmed by the investors after the Mandatory Call Event (MCE) since there may be some time lapse between Mandatory Call Event time and suspension of the CBBC trading. Any trades executed after the MCE will not be recognized and will be cancelled. Therefore, investors should be aware of the risk and ought to apply special caution when the CBBC is trading close to the Call Price.

3) Funding costs

The issue price of a CBBC includes funding costs, which are gradually reduced over time as the CBBC moves towards expiry. In the event that a CBBC is called, investors will lose the funding costs for the remaining period of the CBBC.  

Risks Involved in Trading Derivative Warrants

1) Time decay risk

All factors being equal, derivative warrants value will decay over time as it approaches expiry. Derivative warrants would have no value upon expiry and should not be viewed as a long-term investment.

2) Volatility risk

Prices of derivative warrants may or may not increase or decrease in line with the implied volatility of underlying asset price. Investors should be aware of the volatility of the underlying asset.

Risks Involved in Trading Exchange Traded Funds (ETF)

1) Market risk

An ETF is exposed to the economic, political, currency, legal and other risks of a specific sector or market related to the index and the market that it is tracking.  

2) Tracking error risk

This is the disparity between the performance of the ETF and the performance of the underlying benchmark.  Tracking error may arise due to various factors such as changes in the composition of the underlying benchmark and type of ETF  (e.g. physical vs synthetic), failure of the ETF’s tracking strategy, impact of fees and expenses, foreign exchange differences between the base currency or trading currency of the ETF and the currencies of the

Underlying investments.

3) Risk in trading at discount or premium to NAV

As the trading price of the ETF is typically determined by the supply and demand factors, the EFT may trade at a price higher or lower than its Net Asset Value  (NAV).  In the case when the ETF is terminated, investors who bought at a premium may suffer a loss and would not be able to recover it through the fund.

4) Foreign exchange risk

Investors trading ETFs with underlying assets not denominated in their same local currency are exposed to exchange rate risk. Currency rate fluctuations can adversely affect the value of the underlying asset of an ETF, thus affecting the price of the ETF.

5) Liquidity risk

Market makers help to provide liquidity to facilitate trading in ETFs. Although one or more market makers support most ETFs, there is no assurance that active trading will be maintained. In the event that the market makers default or cease to fulfill their role, investors may not be able to buy or sell the ETF or may find the market price of the ETF is at a discount or premium to its NAV.

6) Counterpart Risk involved in ETFs with different replication strategies

(A) Full replication and representative sampling strategies

Under a full replication strategy, an ETF generally aims to invest in all  constituent stocks/assets in the same weightings as its benchmark.  Under a representative sampling strategy, an ETF invests in                some, but not all of the relevant constituent stocks/assets.      For ETFs that invest directly in the underlying assets rather than through synthetic instruments issued by third parties, counterparty risk tends to be less of concern.

(B)  Synthetic replication strategies

Synthetic ETFs may invest in over-the-counter derivatives issued by counterparties and thus may suffer losses potentially equal to the full value of the derivatives issued by a counterparty upon its default. Hence, synthetic ETFs are exposed to both the risks of the underlying stocks / assets as well as the default risk of the counterpart that issues the financial derivative instruments for replicating the performance of the index.  Some synthetic ETFs may invest in financial derivatives issued by a number of counterparties to diversify counterparty credit risk concentration.  However, the more counterparties an ETF has, the higher the mathematical probability of the ETF being affected by a counterparty default which may lead to losses to the ETF.  Synthetic replication ETFs can be further categorized into two forms:

I.              Swap-based ETFs:  

                ETF managers may replicate the benchmark performance through total return swaps without purchasing the underlying assets.  Swap-based     ETFs would expose to counterparty risk of the swap dealers and may suffer losses if such dealers default.  

II.            Derivative embedded ETFs:

                ETF managers may synthetically replicate the economic benefit of the relevant benchmark by the use of other derivative instruments.  These                 instruments may be issued by one or multiple issuers.  Derivative embedded ETFs would expose to counterparty risk of the instruments’                 issuers  and may suffer losses if such issuers default.  Further, potential contagion and concentration risks of the derivative issuers should be   taken into  account (e.g. since derivatives issuers are predominantly international financial institutions, the failure of one derivative              counterparty of a synthetic ETF may have a “knock-off” effect on the other derivatives counterparty of a synthetic ETF.  

Some ETFs may acquire collateral, but it may subject to counterparty risk if the collateral provider is not fulfilling its obligations.  There is a further risk that when the right against the collateral is exercised, the market value of the collateral could be substantially less than the amount secured resulting in significant loss to the ETF.

(7) Stock lending risk

An ETF which engages in stock lending faces the risk that the borrower may not return the securities lent by the ETF as agreed, and thus the ETF may experience losses due to its stock lending activities.

Risks Involved in Trading Equity Linked Instruments (ELIs)

1) Possibilities of losing investment

Investors may lose part or all of their investment if the price of the underlying security moves against their investment view.  

2) Exposure to equity market

Investors are exposed to price movements in the underlying security and the stock market, the impact of dividends and corporate actions and counterparty risks.  Investors must also be prepared to accept the risk of receiving the underlying shares or a payment less than their original investment.

3) Price adjustment

Investors should note that any dividend payment on the underlying security may affect its price and the payback of the ELI at expiry due to  ex-dividend pricing.  Investors should also note that issuers may make adjustments to the ELI due to corporate actions on the underlying security.

4) Potential yield

Investors should consult their brokers on fees and charges related to the purchase and sale of ELI and payment / delivery at expiry.  The potential yields disseminated by the Hong Kong Stock Exchange have not taken fees and charges intoconsideration.

5) Interest rates

While most ELIs offer a yield that is potentially higher than the interest on fixed deposits and traditional bonds, the return on investment is limited to the potential yield of individual ELIs.

 

Risks Involved in Trading Stock Options

1) Variable degree of risk

Transaction in stock options carries a high degree of risk.  Purchasers  and  sellers  of  stock  options  should  familiarize themselves  with  the  type  of  option  (i.e.  put  or  call)  which  they contemplate  trading  and  the  associated  risks.  Investors should calculate the extent to which the value of the stock option must increase for investors’ position to become profitable, taking into account the premium and all transaction costs. The purchaser of stock  option may  offset  or exercise the stock option or allow the stock option to expire. The exercise of a stock option results either  in  a  cash  settlement  or  in  the  purchaser acquiring  or  delivering  the  underlying  interest.  If the purchased stock options  expire  worthless,  the  purchaser  will  suffer  a  total loss of the purchaser’s investment which will consist of the stock option   premium   plus   transaction   costs.   If   investors   are contemplating purchasing deep-out-of-the-money stock options, investors should be aware that the chance of such stock options becoming profitable ordinarily is remote.

Selling  (“writing” or “granting”) a stock option generally entails considerably greater risk than purchasing a stock option. Although the premium received by the seller is fixed, the seller may sustain a loss well in excess of that amount. The seller will be liable for additional  margin  to  maintain  the  position  if  the market  moves  unfavourably.  The seller will also be exposed to the risk of  the  purchaser  exercising  the  stock  option  and  the seller will be obligated to either settle the stock option in cash or to acquire or deliver the underlying interest. If the stock option is “covered”  by  the  seller  holding  a corresponding  position  in  the underlying  interest  or  another  stock  option,  the  risk  may  be reduced.  If  the  stock  option  is  not  “covered”  (also  known  as “naked”), the risk of loss can be unlimited.   Certain exchanges in some jurisdictions permit deferred payment of the option premium, exposing the  purchaser  to  liability  for margin payments not exceeding the amount of the premium. The purchaser is still subject to the risk  of  losing  the  premium  and transaction costs. When the option is exercised or expires, the purchaser is responsible for any unpaid premium outstanding at that time.

2) Terms and conditions of stock option contracts

Investors should ask the firm with which investors deal about the terms and conditions of the specific stock option which investors are trading and associated obligations (e.g. expiration dates and restrictions on the time for exercise).  Under certain circumstances the specifications of   outstanding contracts (including the exercise price of an options) may be modified by the exchange or clearing house to reflect changes in the underlying interest.

3) Suspension or restriction of trading and pricing relationships

Market conditions  (e.g.  illiquidity)  and/or  the  operation  of  the rules  of  certain  markets  (e.g.  the  suspension  of  trading  in  any contract  or  contract  month  because  of  price  limits  or  “circuit breakers”) may increase the risk of loss by making it difficult or impossible  to  effect  transactions  or  liquidate/offset  positions.  If investors have sold options, this may increase the risk of loss.  

Further, normal pricing relationships between the underlying interest and the option may not exist. This can occur when, for example, the interest underlying the option is subject to price limits while the option is not.  The absence of an underlying reference price may make it difficult to judge “fair value”.

 

I/We acknowledge that I/we have read and fully understood this Risk Disclosure Statement and I/We am/are willing to accept the risks associated with trading derivative products.