Applications of

Stock Futures and Options

(SFO)

HKEx
Aug 2001
1
 SFO Seminar
• Briefing
• SFO Concept
• Advantages of Trading SFO
• How to Apply SFO to Attain Investment Objectives?
• Feasible SFO Strategies
• Features of Exchange Traded SFO Contracts
• Risks and Points to Note in SFO Trades
• Q &A
• Appendix-Available SFO in HKEx
2
 Briefing
• Stock futures contracts have been trading since Mar 1995.
• Stock options contracts have been trading since Sept 1995.
• SFO development:
– Aug 6, 2001
• stock options trading is migrated from the Traded OPtions
System (TOPS) to HKATS( i.e.trading on the same electro
nic platform with stock futures and other derivatives)
– Aug 27, 2001
• contract multiplier for stock futures reduces to the board l
ot size of the underlying stock
• more SFO contracts available for trading in HKEx

3
 SFO Concept(1)
Stock Futures
A legally binding
agreement to buy or
sell an underlying
instrument
Specifying:
on a future date (expiry date),
at a contract price,
to buy (long) or sell (short)
a specific amount of shares
Stock Options
An agreement gives the buyer the
right to buy or sell an underlying
instrument
Specifying:
on or before a future date (expiry date),
at an exercise price (strike),
to buy (call) or sell (put)
a specific amount of shares
4
 SFO Concept(2)
Stock Futures Stock Options
The buyer: The buyer buys:
•a call option with the right to
• buys (long position) purchase stocks
stock futures • a put option with the right to sell
stocks

The seller sells:

The seller: •a call option with the obligation to sell
• sells (short position) the stocks when being exercised
• a put option with the obligation to
stock futures purchase the stocks when being
exercised

5
 SFO Concept(3)
Stock Futures
Both buyer and seller must
deposit margins
• open positions are subject
to daily mark to market
• if an account balance falls
below the maintenance
margin level, an
additional deposit is
required(margin call)
Stock Options
• buyer pays a premium to buy the
option
• seller receives the premium and is
required to deposit a margin at the
same time
On or before the expiry:
• buyer can sell or exercise the option,
or let it expire worthless
• seller can buy the option to close out
position, or fulfill contract
requirements if the option sold is
exercised
6
The PNL Analysis of Futures Positions

PNL Long PNL

Short
Buyer Seller

Stock Price Stock Price

on Expiry on Expiry

7
 The PNL Analysis of Options Positions
Buyer Buyer
PNL Call Put
PNL

Stock Price
Stock Price
on Expiry
on Expiry

Seller
PNL
Seller
PNL
Stock Price
on Expiry
Stock Price
on Expiry

8
 Advantages of Trading SFO(1)
• Feasible to combine trades with the underlying
stocks
• Effective to hedge stocks and other derivatives
• Possible to catch investment opportunity based on
individual stock performance
• Flexible to apply in bullish, bearish, volatile, and
stagnant (options) markets
• Convenient to short selling
– by shorting stock futures or calls, or buying puts to
catch profits from a price fall
9
 Advantages of Trading SFO(2)
• Cost effective money management tool
– trading stock futures or shorting options is required to
deposit margins, while buying options is required to pay
the premium
• Providing market liquidity and connectivity
• Lower currency exposure for offshore investors
• Market making system
– enhancing market liquidity and efficiency
• Same electronic trading system (HKATS)

10
 Advantages of Trading SFO(3)
• Clearing house guarantee

Risk management tool

-counterparty to all open contracts
-the performance guarantee on registered contracts
-the quality of clearing participants
-mark to market
-position limits
-Reserve Fund

11
 Advantages of Trading SFO(4)
• Low transaction costs
Comparison of transaction costs (per side):
HWL@$80, a HWL futures contract is valued @$80K, and a HWL option @$5
Stock futures Stock Options
Minimum commission*: $20 0.25%#
Exchange fee: $3.5 $5.0
SFC levy: $1.0 Nil
Compensation Fund levy: $0.5 Nil
Stamp Duty: Nil Nil+
Total: $25 0.25%+$5
Transaction costs ($) $25 $55

*
Before 1 Apr 2003
#
Not less than 0.25% of the transaction value with a min of $50
+
Stamp Duty applies to exercising options (amount equivalent to trading stocks)12
 Advantages of Trading SFO(5)
• Leverage effect
PNL($) HSBC Stock Futures- Long a Futures
15

10

5 +55%
-11% +11%

0
80 85 90 95 100
-5
-55%
- 10

Assume 20% of the traded value as the client margin 13

- 15
• Leverage effect (continued)
PNL($)
HSBC Stock Options- Long a Call
8

4 +200%

0
88 89 90 91 92 93 94 95 96 97 97 99
-2 +6.45%

-4 Assume the call premium@$3

14
How to Apply SFO to Attain Investme
nt Objectives?

• Trading strategies
• Hedging strategies
• Income enhancement strategies (options)
• Leverage effect
• Arbitraging strategies

15
 Feasible SFO Strategies

Bullish
• Directional trades
• Hedging strategies
Stagnant • Income enhancement
strategies (options)
• Stop loss strategies
Bearish

16
 Directional Trades--Bullish Strategies(1)
Anticipated a bullish market:
• A targeted stock is expected to rise within this month or next
• Going to have sufficient capital to purchase the stocks later
• Now with enough money to deposit margins/pay an option
premium

Possible strategies:
1.Long stock futures
2.Purchase a call on the stock
3.Sell a put on the stock

17
 Directional Trades--Bullish Strategies(2)
Possible strategy(1): Long stock futures

* Example:in early July, HSBC @$91

Buy Jul HSBC futures @$91.25

* Advantages: deposit the margin

low initial investment costs
leverage effect

18
Analysis:
• If the stock futures price rises above the purchase price,
investor can sell the stock futures to profit from the
accumulated price appreciation, or wait until the expiry to
determine the PNL
• If the stock futures price falls below the purchase price,
investor incurs a loss.
– If the accumulated loss makes the account balance drop below the
maintenance margin level, he must deposit an additional margin
– or investor can sell the stock futures to close out his position before
the expiry so as to stop further losses

19
 Directional Trades--Bullish Strategies(3)
Possible strategy(2): Purchase a call on the stock

* Example:in early July, HSB @$82.25

Buy Jul HSB 85 call @$1.46

* Advantages: low initial investment costs

leverage effect
limited risk

20
Analysis:
• If stock price rises above exercise price, investor can sell the
call option to profit from the price appreciation, or exercise
to purchase the stock at $85 (the actual purchase price is
$86.46=$85 +$1.46) and earn the price difference between
the market price and $86.46
• If stock price falls below exercise price, the investor’s
maximum loss is limited to the premium paid; on the other
hand, investor can then purchase the stock at a price lower
than the exercise price.

21
 Directional Trades--Bullish Strategies(4)
Possible strategy(3): Sell a put on the stock

* Example:in early July, HWL @$75.5

Sell Aug HWL75 put and receive @$2.02

* Advantages: enhanced income from the received premium

if the sold put is exercised, investor can
lock in the purchase stock price

22
Analysis:
• If stock price rises above exercise price, the sold put expires
worthless and the seller can receive the premium

• If stock price falls below exercise price and the put is

exercised, investor will need to purchase the stock at strike
(the actual purchase price is $72.98=$75-$2.02)

23
Directional Trades--Bearish Strategies(1)
Anticipated a bearish market:
• A targeted stock is expected to fall within this month or next
• Stock short-selling requires borrowing stocks plus
borrowing cost
• Now with sufficient capital to deposit margins/pay an option
premium

Possible strategies:
1.Short stock futures
2.Buy a put on the stock
3.Sell a call on the stock

24
 Directional Trades--Bearish Strategies(2)
Possible strategy(1): Short stock futures

* Example:in early July, HSBC @$89.25

Short Jul HSBC futures @$89.34

* Advantages: low initial investment costs

leverage effect
ease of short-selling

25
Analysis:
• If stock futures price rises above selling price, investor
incurs a loss.
– If the accumulated loss makes the account balance drop below the
maintenance margin level, he must deposit an additional margin
– or investor can buy the stock futures back to close out his position
before the expiry so as to stop further losses

• If stock futures price falls below selling price, investor can

buy stock futures to profit from the accumulated price
depreciation, or wait until the expiry to determine the PNL

26
 Directional Trades--Bearish Strategies(3)
Possible strategy(2): Buy a put on the stock

* Example:in early July, HSB @$82.25

Buy Jul HSB 80 put @$4.5

* Advantages: low initial investment costs

leverage effect
limited risk

27
Analysis:
• If stock price rises above exercise price, let the put expire
worthless. The investor’s maximum loss is limited to the
premium paid

• If stock price falls below exercise price, investor can

– sell the in the money put to profit from the option trades
– or exercise the option to sell the stocks at $80 (the actual selling price
is $75.5=$80-$4.5)

28
 Directional Trades--Bearish Strategies(4)
Possible strategy(3): Sell a call on the stock

* Example:in early July, HWL @$75.5

Sell Aug HWL 80 call , receive @$1.08, and deposit an initial
margin

* Advantages: enhanced income from the received premium

if the sold call is exercised, the investor can
lock in the stock selling price

29
Analysis:
• If stock price rises above exercise price:
– the call is exercised, investor will need to sell the stock at strike ( the
actual selling price is $81.08=$80+$1.08)
– or he can buy back the call to close his position to reduce further
losses

• If stock price falls below exercise price, the sold call expires
worthless and investor can earn the full premium

30
 SFO Hedging Strategies
• Hedge against downside risk
– an investor with stocks can lock in a portfolio
value by shorting futures or buying puts to
protect against the value from being depreciated
at times of falling prices
• Hedge against upside risk
– an investor planing to purchase stocks can lock in
the purchase value by buying futures or calls in
the market expected to be bullish

31
 Hedging Strategies(1)

Scenario:
• Plan to purchase the targeted stocks later
• Worry about
- an expected price rise before the purchase
- a miss to catch the investment opportunity

Possible strategies:
1.Long stock futures
2.Buy a call on the stock

32
 Hedging Strategies(2)
Possible strategy(1): Long stock futures
Hedge against upside risk:
* Example: in early July, CITIC@$23.2. Investor would like to buy the
stock, but he does not have sufficient capital until one month later to make
the purchase.

He can purchase Aug CITIC futures @23.35

* Advantages and Analysis:

–if stock price rises, investor with the long futures position
can lock in the purchase price
–if stock price falls, the lower market price can offset the loss from the
futures bought. Thus, investor can still lock in the purchase cost at
the predetermined price

33
 Hedging Strategies(3)
Possible strategy(2): Buy a call on the stock
Hedge against upside risk:
* Example: in early July, CLP@$32.6. Investor would like to buy the stock,
but he does not have sufficient capital until one month later to make the
purchase.

He can purchase Jul CLP 32 call @$0.88

* Advantages and Analysis:

–limited risk
–if stock price rises, investor can lock in the purchase at strike
–if stock price falls, investor can choose to buy the stock at a lower
market price and let the call expire worthless

34
 Hedging Strategies(4)
Scenario:
• Plan to hold the stock as a long term investment while
worry about an expected price fall in the short term
• Going to receive some stocks later while worrying about a
miss to leave the market at the current level

Possible strategies:
1.Short stock futures
2.Buy a put on the stock

35
 Hedging Strategies(5)
Possible strategy(1): Short stock futures
Hedge against downside risk:
* Example: in early July, HKEL@$30.1. Investor would like to hold the
stock as a long term investment to receive dividends, but worrying about a
potential price drop.

He can short Jul HKEL futures @30.05

* Advantages and Analysis:

–if stock price falls, investor with the short futures can lock in the stock
price
–if stock price rises, the higher market price can offset the loss from the
short futures position. Thus, investor can still lock in the portfolio
value at his predetermined price
36
 Hedging Strategies(6)
Possible strategy(2): Buy a put on the stock
Hedge against downside risk:
* Example: in early July, SHK@$72. Investor will receive stocks later and
would like to lock in the value at the current level.

He can purchase Jul SHK70 put @$1.46

* Advantages and Analysis:
–limited risk
–if stock price falls, investor can lock in the stock value at the
exercise price
–if stock price rises, investor can choose to hold the stock or sell it
at a higher market price and let the put expire worthless

37
 Income Enhancement Strategies(1)
Scenario:
• Market is expected to be stagnant
• Desire to receive an additional income from the stock
held or cash on hand

Possible strategies:
1.Short a call (Risky to seller when the call becomes in the money
and is exercised, then he is required to sell the stock at exercise
price in the bullish market)
2. Short a put (Risky to seller when the put becomes in the money
and is exercised, then he is required to buy the stock at the
exercise price in the bearish market)

38
 Income Enhancement Strategies(2)
Possible strategy(1): Short a call
Stagnant to bearish market:
* Example: in early July, CKH@$82.5.
Investor with the stock anticipates the market to be stagnant to bearish.

He can short Jul CKH 85 call @1.16

* Advantages and Analysis:

– investor can earn the received premium in sticky market
–if stock price falls below$85, the sold call expires worthless
–if stock price rises above $85, the call becomes in the money. When
the call is exercised, seller is required to sell the stock at strike.
(The actual selling price is at $86.16=$85+$1.16)

39
 Income Enhancement Strategies(3)
Possible strategy(2): Short a put
Stagnant to bullish market:
* Example: in early July, HSB@$82.25.
Investor with cash on hand anticipates the market to be stagnant to bullish.

He can short Jul HSB 80 put@$0.76

* Advantages and Analysis:

–investor can still earn the received premium in sticky market
–if stock price rises above $80, the sold put expires worthless
–if stock price falls below$80, the put becomes in the money. When
the put is exercised, seller is required to buy the stock at strike.
(The actual purchase price is at $79.24=$80-$0.76)

40
 Stop Loss Strategies(1)

Scenario:
• With sold options going to become in the money
• Plan to reduce or stop the potential loss which may arise from
the short positions

Possible strategies:
1.Long stock futures to cover the naked call sold
2.Short stock futures to protect against the put sold

41
 Stop Loss Strategies(2)
Possible strategy(1): Long stock futures to cover the naked call sold

* Example: Sold Jul HWL$75 call.

In early July, HWL price rises to near the call strike . Investor is
worried about the potential risk involved in his position when
the call sold becomes in the money.

He can purchase Jul HWL futures contract @$75

42
*Advantages and Analysis:
–the potential risk of writing a naked call is when the call becomes in the
money and is exercised, then seller is required to purchase the
underlying stock at the market and sell it at exercise
price in a bullish market

–if stock price rises, profit from the long futures position can
cover losses in the call sold

–if stock price falls below:

1. exercise price , investor can receive the premium
2. futures purchase, he can sell the futures to reduce further losses of
it at a price fall

43
 Stop Loss Strategies(3)
Possible strategy(2): Short stock futures to cover the put sold

* Example: Sold Jul SHK$70 put.

In early July, SHK price drops to near the put strike . Investor
is worried about the potential risk involved in his position when
the put sold becomes in the money.

He can short Jul SHK futures contract @$70

44
*Advantages and Analysis:
–the potential risk of a put sold is when the put becomes in the money
and is exercised, seller is required to purchase the underlying
stocks at strike in a bearish market and the stock price continues
to drop after the purchase

–if stock price falls, profit from the short futures can repair the loss in
the put sold

–if stock price rises above:

1. exercise price , investor can receive the premium
2. futures selling price, he can buy the futures back to reduce
further losses of it in a price rise.

45
Features of Exchange Traded SFO contracts(1)
Commission
Stock futures Stock options
• Before 1 April, 03*: • Before 1 April, 03 ：
HK$20 (overnight) Not less than 0.25% of the tr
HK$12 (day-trade) ansaction value
The minimum commission
HK$50
• on or after 1 April, 03 : • on or after 1 April, 03 :
Negotiable Negotiable

*applicable to 16 specified stock futures, and the commission for the rest is
negotiable for each contract per side 46
 Features of Exchange Traded SFO contracts(2)
Stock futures Stock options
• Contract value: • Contract value:
Contract price X Contract Option premium X Contract
multiplier size

• Trading fees*: • Trading fees:

HK$5.0 Tier1:HK$5.0
Tier2:HK$1.0

*including the Exchange Fee, SFC Levy ,and Compensation Fund Levy (for each
contract per side) 47
Features of Exchange Traded SFO contracts(3)

Stock futures Stock options

• Final Settlement Price: • Final Settlement
The average of the cash stock Price:
midpoints of the best bid/ask (Not applicable)
prices taken at 5 min intervals
during the last trading day
• Settlement method:
• Settlement method:
Cash settled
Physical delivery

48
Features of Exchange Traded SFO contracts(4)

Stock futures Stock options

• Settlement day: • Settlement day:
The first business day T+1(options premium
after the last trading day payable in full)
T+2(stock transfer following
the exercise)

• Exercise style:
any time up to 5:30p.m. on
or before the last trading day

49
 Features of Exchange Traded SFO contracts(5)
Same contract months,trading hours, and last trading day
• Contract months:
Spot, the next two calendar, and the next two quarter
months
• Trading hours (Hong Kong time):
10:00a.m.-12:30p.m.
2:30p.m.-4:00p.m.
• Last trading day (expiry day):
The business day preceding the last business day of the
contract month

50
 Risks of SFO trades

Stock futures Stock options

• Margin requirement • Factors affecting the
– if the account balance option premium
falls below the – investor should pay
maintenance margin attention to changes of
level, investor is market and factors
required to deposit an influencing the option
additional fund to value. Select the contract
restore the account to with a suitable expiry
the initial level and strike at option
trades

51
 Risks of SFO trades
Margin Initial
Requirement Margin

If the margin account

balance falls below the
maintenance margin Maintenance
level, the investor is Margin
required to deposit an
additional fund to
restore the account to
the initial margin
level
If the investor cannot provide the required fund for the margin
call within the specified time period, the broker has the right to
close out the investor’s position immediately in the market. The
investor is responsible for all the losses. 52
 Risks of SFO trades
Stock futures
• Trading on margin
basis
– trading futures provides
investors flexibility in
money management;
however,investors should
also pay attention to the
capital liquidity to ensure
their fulfillment of
potential margin calls
Stock options
• At the time of option
exercise
– buyer must provide:
* sufficient capital ready to buy
the stocks (a call)
* the required stocks ready to sell
(a put)
– seller must prepare:
* the required stocks ready to sell
(a call)
* sufficient capital to buy the
stocks (a put)
53
 Leverage Risk
HSBC Stock Futures-Long a Futures
PNL($)
15

10

5 +55%
-11% +11%

0
80 85 90 95 100
-5
-55%
- 10

- 15
Assume 20% of the traded value as the client margin 54
 Leverage Risk

PNL($) HSBC Stock Options- Short a Call

3

1 +6.45%

-1 88 89 90 91 92 93 94 95 96 97 97 99 100

-3
-200%

-5

-7
Seller deposits margin for selling the call
55
 Points to Note in SFO Trades
• Contract month
– choose the right contract month to allow expected
market direction to realise
– SFO (with expiry) vs stocks (no expiry)
• Leverage
– the actual investments of futures investors and options
sellers are much larger than the margins initially
deposited as a portion of the contract value
• Trading amount
– have sufficient capital to fulfill the contract settlement
– do not trade excessively 56
 Points to Note in SFO Trades
• Be familiar with contract specifications and
settlement procedures
• Pay attention to the market changes in direction
and volatility
• Construct feasible trading strategies
• Set stop loss or hedge strategies
• Prepare sufficient capital to fulfill contract
requirements and margin calls
• Consult registered brokers or investment
advisers for professional advice
57
How to Obtain Market Information?
• List of real time quote vendors:
– downloadable from HKEX website
– e.g. ABC, Jade Network, or Star Internet
– e.g. TeleText
• SF-on and after Page 785
• SO-on and after Page 3001
• Non real time information:
– Local newspapers
– HKEx website
58
 How to Start Trading SFO?
• Obtain a list of qualified market participants from HKEx
• Inquire for opening account procedures and service
charges from the qualified participants
• Select and open an account with the one best fit to your
needs
• Ensure to read and understand the risk disclosure
documents before signing
• Establish market view before constructing trading
strategies
• Participate SFO trades by placing orders in the market

59
Q&A

60
For Detailed Information,
Please Visit:
http://www.hkex.com.hk

61
 Appendix-Available SFO in HKEx
(as of 27/08/01)
STOCK STOCK LOT OPTIONS
CODE SIZE TIER
#1 0941 China Mobile 500 1
#2 0001 Cheung Kong Holdings 1,000 1
#3 0002 CLP Holdings 500 1
#4 0267 CITIC Pacific 1,000 1
#5 0291 China Resources 2,000 1
#6 0012 Henderson Land 1,000 1
#7 0011 Hang Seng Bank 100 2
#8 0006 Hongkong Electric 500 2
#9 0054 Hopewell Holdings 1,000 2
#10 0005 HSBC Holdings Plc 400 1
#11 0013 Hutchison Whampoa 1,000 1
12 0992 Legend Holdings 2,000 1

62
 Appendix-Available SFO in HKEx
(as of 27/08/01)
STOCK STOCK LOT OPTIONS
CODE SIZE TIER
#13 0017 New World Development 1,000 1
14 0008 Pacific Century 1,000 2
#15 0016 Sun Hung Kai Properties 1,000 1
#16 0363 Shanghai Industrial Holding 1,000 1
#17 0019 A Swire Pacific A 500 1
18 0023 The Bank of East Asia Ltd 200 2
19 857 PetroChina Co. Ltd 2,000 2
#20 0004 Wharf Holdings 1,000 1
21 0293 Cathay Pacific Airways Ltd 1,000 1
22 1083 Cheung Kong Infrastructure 1,000 1
23 133 China Merchants Holdings 2,000 2
24 762 China Unicom Ltd 2,000 2

63
 Appendix-Available SFO in HKEx
(as of 27/08/01)
STOCK STOCK LOT OPTIONS
CODE SIZE TIER
25 1199 COSCO Pacific Ltd 2,000 1
26 3 Hong Kong and China Gas 1,000 2
27 388 HKEx 2,000 1
28 179 Johnson Electric Holdings 500 2
29 494 Li & Fung Ltd 2,000 1
30 66 MTR Corporation Ltd 500 2
*31 2800 Tracker Fund of Hong Kong 500 2

* No futures contracts on the Tracker Fund of Hong Kong for trading

# Before 1 April, 03, the minimum commission rate for each marked
contract per side is HKD20.0 (overnight) or HKD12.0 (day-trade);
commission for others futures contracts is negotiable. On or after 1 April,
03, the minimum commission rate will be negotiable for all stock futures
contracts. 64