Warrant and CBBC volumes recover after slump

Appetite for warrants and callable bull/bear contracts in Hong Kong improved over the course of 2009, a trend HSBC expects will continue in 2010.

HSBC says that warrants and callable bull/bear contracts (CBBCs) will find favour with investors in 2010, continuing a trend that gained momentum in 2009.

"Our warrant/CBBC total turnover dropped 23% in 2009 to around HK$3.4 trillion ($438 billion)," said Keith Chan, the head of listed products sales in HSBC's global markets team, who joined the bank in September. Speaking at a recent market review session, he attributed this decline to the relatively weak performance of the Hong Kong stock market in early 2009. However, warrant and CBBC turnover increased each quarter during 2009, and was back to about mid-2008 levels by the last quarter of 2009.

HSBC said warrants made up roughly half of that turnover last year, giving the bank a 10.8% share of the total market turnover. Demand for call warrants was higher than for put warrants during the year, reflecting investors' bullish sentiment on Asia's economic recovery. They expressed this optimism mostly through bets on the Hang Seng Index and Chinese names in the financial, oil and telecom industries.

The number of underlying stocks or indices that investors can buy warrants on jumped 16% in 2009, bringing the total to 126. Chan said improved sentiment and greater diversity will boost demand for the "non top-10" underlyings in 2010. "As investors become more mature and sophisticated in both risk diversification and risk management, they will be willing to explore different sectors in the warrant market," he said.

There are also technical factors supporting the revival of the warrant market, according to Chan. "Implied volatility has declined sharply since the financial crisis in 2008 and we expect that it will become more stable next year," he said.

Today, implied volatility is back to around mid-2008 levels and some equity warrants are even trading at around 2007 levels. This makes a big difference to investors as the level of volatility determines the effective gearing of warrants -- in effect, high levels of volatility make warrants more expensive and therefore less attractive to investors. Indeed, investors turned to CBBCs as a cheaper alternative to warrants at the end of 2008 and the first quarter of 2009, but the drop in volatility has since turned attention back to the warrant market.

Chan said that he expects a 10% to 20% increase in warrants/CBBC turnover in 2010. Regarding the CBBC market in Hong Kong, HSBC said its turnover of HK$1.7 trillion for 2009 represented an 11% share of total market turnover. 

In 2010, HSBC expects that CBBCs will be used primarily as a short-term investment instrument due to investors' increasing awareness of the knock-out feature of the product. More than 90% of the total turnover in CBBCs is generated from contracts on the Hang Seng Index. 

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