How do quotes affect payoffs

Structured products
Warrants
CBBCs
Inline warrants


As the liquidity of structured products mainly depends on the issuers, the liquidity providers’ quotes play a key role in the structured products market.

Liquidity providers appointed by issuers may quote the bid and ask prices for structured products based on various factors, including the theoretical prices of structured products, underlying asset price (or level if the underlying asset is an index) and hedging costs; they will also determine the quote size – the bigger the quote size, the higher the liquidity. The price at which investors buy or sell a structured product and whether a structured product is easy to trade will depend on the quotes provided by the liquidity providers.

The quality of the liquidity provider’s quote is determined by two factors – bid-ask spread and quote size.

Bid-ask spread

The bid and ask prices quoted by the liquidity providers directly reflect the transaction cost to the investors. Investors buy at the ask price and sell at the bid price so a smaller spread generally means a lower transaction cost. A tick is the smallest unit of bid-ask spread. The following table shows the value of a tick within different listed structured products’ price ranges. Please visit the website of HKEX for the full spread table.

Listed structured product  price range ($) Bid-ask spread value for each tick ($)
0.01 – 0.25 0.001
Over 0.25 – 0.5 0.005
Over 0.5 – 10 0.01
Over 10 – 20 0.02


Investors should pay attention to the consistency of the quoted price provided by the liquidity providers. Ideally, the spread should stay within a narrow range most of the time. As market information becomes more transparent, useful tools are offered on the websites of the issuers or financial news platforms for investors to compare the quality of the liquidity providers’ quotes, such as the average bid-ask spread or the 1 tick spread duration (i.e. how long the spread of a product is maintained within a single tick).

Quote size

Apart from the quoted price, investors should also check the quote size (liquidity) provided by the liquidity providers, which reflects the volumes of transaction that can take place at the current trading price. Theoretically speaking, a larger quote size represents a higher liquidity and more flexible a transaction can be.

With a larger quote size from the liquidity providers, liquidity providers can accommodate more orders from more investors and of larger volumes. On the contrary, investors may have to buy or sell the structured products in smaller batches at less desirable prices if the quote size is small. Low liquidity may not be a problem when the market is stagnant or the performance of the underlying asset is in line with your expectations, but it could be a big issue if the market is volatile or investors have to stop loss.

 

22 January 2021