Guide for the More Experienced

The cost of a CBBC is relatively low, so the subsequent potential increase can be captured?
  • Like a warrant (see Warrant.Guide for the More Experienced: Locking in Profit for details), in addition to directional hedging (buying on the upside or buying on the downside), CBBCs can also play other roles in asset allocation. When the price of the stocks held by an investor rises, he may have the following thoughts:
    1. He may want to lock in the profit, but he is afraid that if he sells too early, he will miss subsequent potential rises of the stock price.
    2. He may want to wait for more rises of the stock price, but he is afraid that if he sells too late, the stock price will drop.
    At this time, CBBCs can play the role of locking in profit. The investor may first sell his stocks to make a profit, and then buy some bulls at the right proportion. Since the investor only needs to pay the difference between spot price and exercise price in buying bulls, if the stock price rises later, he may enjoy the rise of the underlying asset's price through an increase in the intrinsic value; if the stock price falls later, since CBBCs have the function of “sharing of loss”, the maximum loss is limited to the entire principal. Besides, profit has already been locked in for the stocks, further reducing the potential loss.
  • The purchase of CBBCs is actually equivalent to borrowing money from the issuer to buy the underlying assets. After the underlying assets are sold to lock in profit, how many bulls should be bought so that they can be equivalent to the underlying assets for which profits have been locked in? The formula is as follows:
    The number of bulls to be purchased = number of underlying assets x entitlement ratio of CBBC
    For example, say an investor holds 2,000 AIA shares, and intends to continue to benefit from the potential increase after the profit is locked in. Using a 100:1 AIA bull for hedging, the number of bulls to be purchased is
    2,000 x 100 = 200,000
    Since the theoretical value of a bull is the difference between the spot price and call price, the cost of buying 200,000 AIA bulls is lower than that of 2,000 AIA shares. Therefore, the investor can benefit from the trend of the underlying assets at a low cost. When the price of the underlying asset rises, the investor can profit from the bull; if the price of the underlying asset drops, because the profit has been locked in for underlying assets and the maximum loss under a bull is merely the principal, the maximum loss of the investor is limited.
Consolidate your memory immediately!
After selling 500 Tencent shares, if you want to replace the investment with a 500:1 bull A, you need to buy
bulls.
Correct!
The number of bulls to be purchased = number of underlying assets x entitlement ratio of CBBC, that is, 500 x 500 = 250,000.
Wrong!
The number of bulls to be purchased = number of underlying assets x entitlement ratio of CBBC, that is, 500 x 500 = 250,000.