Issuer’s quotes are more important than trading volumes

Whether you are running a business or making an investment, it’s all about liquidity.

Highly liquid or actively traded financial products are normally be transacted more easily and enjoy a narrower bid-ask spread. Trading volume is a common indicator of most of the financial product’s liquidity. Larger trading volume usually means higher liquidity. However, it may not be the case for structured products such as derivative warrants (known as “warrants”), CBBCs and inline warrants.

Investors may make the wrong decision if they choose a structured product simply by looking at its trading volume. Unlike the stock market, the listed structured product market adopts a market making mechanism in which liquidity is mainly driven by the liquidity providers instead of the typical market demand and supply. Liquidity providers will provide quotes and quote size, and investors can trade at the quoted prices offered by the liquidity provider. In most cases, liquidity providers will provide quotes for structured products valued at $0.01 or above. In other words, investors may still trade structured products with the liquidity providers even when there are no buyers or sellers in the market. Under certain circumstances, for example when the theoretical value of a warrant is less than $0.01, liquidity providers are not obligated to provide quotes.

Learn more about the quotes provided by liquidity providers

The lack of trading volume does not mean that liquidity providers cannot provide quotes. Issuers appoint liquidity providers to provide quotes actively for eligible structured products, while investors may also request liquidity providers to provide quotes for any unquoted products, or inquire about the unavailability of a particular quote. As long as liquidity remains relatively stable (i.e. there are sufficient buy or sell orders), investors should be able to sell their investments easily.

The trading volume of structured products only reflects their trading position and may have nothing to do with their liquidity. Moreover, trading volume of structured products varies from day to day. Sometimes high-frequency trading may lead to large accumulated trading volume which may make a structured product appear to be actively traded. However, in practice, positions under high-frequency trading are usually available to the market for just a few seconds before selling out. Investor should not simply translate high trading volume into high liquidity or popularity.

Although liquidity providers offer quotes for structured products, orders may not be executed as the quotes might not meet the investor’s expectation.

Investors may fail to choose the suitable structured products if they overlook their contract terms. Investors with higher risk tolerance may be attracted to contracts with more aggressive terms and would see structured products as short-term investment, eventually pushing up the trading volume. However, investors may be exposed to higher risks if the contract terms of the frequently traded structured products do not coincide with their strategy.