Mandatory call mechanism is a feature of CBBCs under which the trading of CBBCs may be terminated suddenly.
When the underlying asset price (or level if the underlying asset is an index) reaches or exceeds the call price (or level if the underlying asset is an index), CBBCs will expire early under the mandatory call event and their trading will be terminated immediately. A mandatory call event occurs when the underlying asset price of a bull contract reaches or falls below the call price, or when the underlying asset price of a bear contract reaches or rises above the call price.
The difference between a call price and an underlying asset price essentially determines the risks and returns of CBBCs. The smaller the gap, the higher the call risk and the gearing will be.
Determination of residual value
Residual value refers to the value of a CBBC after a mandatory call event.
Residual value of a bull contract = (settlement price – strike price) / conversion ratio
Residual value of a bear contract = (strike price - settlement price) / conversion ratio
Conversion ratio refers to the quantity of CBBCs required to buy or sell one unit of underlying asset.
Settlement price (or level if the underlying asset is an index) refers to the lowest spot price or level of the underlying asset during the observation period (for a bull contract) or the highest spot price or level of the underlying asset during the observation period (for a bear contract).
A mandatorily called Category N CBBC will have no residual value since its call price is equal to the strike price (or level if the underlying asset is an index), and investors will lose all of the money. Most CBBCs available in the market are Category R contracts that have different strike prices and call prices, and investors may be able to receive part of the residual value after a mandatory call event.
When the mandatory call condition is met, i.e. the underlying asset price hits or exceeds the call price, the residual value to be received by the investors will depend on the difference between the settlement price and the strike price during the observation period. During the observation period, the residual value will become zero and investors will lose all of the capital if the underlying asset price touches or exceeds the strike price.
The observation period starts from the moment the mandatory call event occurred and ends at the next complete trading session.
| Mandatory call event occurs during the morning session | Observation period covers the remaining period of the morning session and the following afternoon session |
|---|---|
| Mandatory call event occurs during the afternoon session | Observation period covers the remaining period of the afternoon session and the next morning session |
22 January 2021
