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On a Bull/Bear Contract Call Signal Based Trading Strategy

On a Bull/Bear Contract Call Signal Based Trading Strategy. Callable Bull / Bear Contracts (CBBC). Barrier options with fixed expiry dates, allowing investors to take bullish or bearish positions on the underlying asset.

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On a Bull/Bear Contract Call Signal Based Trading Strategy

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  1. On a Bull/Bear Contract Call Signal Based Trading Strategy

  2. Callable Bull / Bear Contracts (CBBC) • Barrier options with fixed expiry dates, allowing investors to take bullish or bearish positions on the underlying asset. • Usually issued by a third party (e.g., an investment bank) independent of the underlying asset. • Other names: “knock-out”, “stop-loss” Certificates, Contracts for Difference • CBBC will be “called” by the issuer if the price of the underlying asset reaches a certain level.

  3. Game plan • Not about trading of CBBC • Use the call feature of the CBBC to devise a trading strategy of the underlying asset.

  4. How does CBBC work? • Category N CBBC • call price = strike price • CBBC holder will not receive any cash payment if the price of the underlying asset reaches the call price • Category R CBBC • call price ≠ strike price • CBBC holder may receive a small amount of cash payment upon the occurrence of a call event • With the same strike price, category R CBBC may be called earlier than a category N CBBC

  5. Examples (I)

  6. Examples (II)

  7. Examples (III)

  8. Examples (IV)

  9. Other features • Price of CBBC tends to follow closely the price of its underlying asset, but may not be true when the price of the underlying is close to the call price • Introduced in Hong Kong in June 2006. • So far, underlying assets include: • Highly liquid Hong Kong stocks listed on the Exchange: HSBC holdings, Hutchison Whampoa, PetroChina, China Mobile (Hong Kong), Cheung Kong Holdings • Two Hong Kong stock indices: Hang Seng Index & Hang Seng China Enterprises Index

  10. Proposed trading strategy • Generate “call-alert signals” for the CBBC prior to the call event. • If our signal indicates that the Bull (Bear) Contract will be called, then we short-sell (buy) the underlying asset.

  11. Call-alert Signal • Bear Contract: a call-alert signal is produced if the upper bound of the forecast of tomorrow’s high exceeds the call price. • Bull Contract: a call-alert signal is produced if the lower bound of the forecast of tomorrow’s low falls below the call price. • The success of the trading strategy depends crucially on the ability to forecast accurately the daily highs and lows. • Forecast the daily highs and lows via the Box-Jenkins approach.

  12. Data • 14 CBBCs traded on the HKEx between June 2006 and April 2007 • Underlying asset: HSI

  13. Underlying instruments • Underlying asset is an index which cannot be traded directly. • ETF selected: stock code 2833, managed by the Hang Seng Investment Ltd. With the Citigroup Global Markets Asia and Deutsche Securities Asia as market marker.

  14. Trading strategy • Step 1: The forecasting model based on the daily high and low forecasts of the HSI, generates call-alert signals for the Bull/Bear Contract. • Step 2: A call-alert signal is generated for the Bear (Bull) Contract if the upper (lower) bound of the forecast of tomorrow’s daily high (low) reaches the call price. • Step 3: Buy (Short-sell) ETF2833 or after observing the call-alert signal for the Bear (Bull) Contract for m consecutive days.

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