Price and Volume Effects of Exchange-Traded Barrier Options: Evidence from Callable Bull/Bear Contracts

Abstract

This study examines the effects of the Mandatory Call Events (MCEs) of Callable Bull/Bear Contracts (CBBCs) on the underlying stocks. The recent development of CBBCs in Hong Kong creates a unique opportunity to study this new derivative instrument. There are significant abnormal returns and volumes around MCEs. The substantial amount of price reversal after MCEs in both interday and intraday results supports the notion of stock price manipulation. Also, a greater outstanding number of issues in the market increases the chance of MCEs. We also show that the abnormal volume leads to the abnormal returns around MCEs, implying that abnormal trading activities can cause MCEs. This article shows that a market with a substantial amount of touch‐and‐out options trading may induce manipulation of the underlying stocks. Our study suggests that restricting issuers from unwinding hedged positions before the termination of exchange‐traded barrier options could improve investors' protection. © 2014 Wiley Periodicals, Inc. Jrl Fut Mark 35:1042–1066, 2015

Callable bull/bear contracts, call auction sessions, and price manipulations: Evidence from Hong Kong

“…However, when S decreases and reaches H , the MCE is triggered. The contract is then settled with a residual value equivalent to max[ M − X , 0], where M is the settlement price (Lei, 2015). In contrast to a bull contract, a bear contract is like a put warrant with X ≥ H > S .…”

“…Suen and Wan (2013) argue that the HKEx is the only major stock exchange that introduced a CAS without any precautions against price manipulation, and that the mechanism facilitates manipulation during the CAS because of its substantial price limit (nine‐times restriction rules) and its fixed closing deadline. As CBBC issuers are prone to manipulating the prices of CBBC underlying stocks to trigger MCEs to lock in their profits (Cheung, Chou, & Lei, 2015; Lei, 2015), such a simple closing call auction mechanism is vulnerable to their manipulations. Therefore, the price manipulation of CBBC underlying stocks is likely to occur in the previous CAS period.…”

“…We focus on the CBBC, one of the most traded barrier options in the world, to study the probability of mandatory call events (MCEs) as triggered by price changes of CBBC underlying stocks during auction sessions. The mandatory callback feature of the CBBC provides incentives for CBBC issuers to manipulate the prices of CBBC underlying assets to trigger MCEs (Lei, 2015). Further, since June 12, 2006, when they began to be traded on the HKEx, CBBCs have had the largest trading volume in the Hong Kong stock market and among all stock markets.…”

Risk Analysis and Hedging of Parisian Options Under a Jump-Diffusion Model

“…However, in recent years, the growth of barrier options has slowed down compared to the fast growth in the early 2000's (see, for example, the report on the Bank for International Settlements [2015] which documents the overall market movements). Nonetheless, new financial innovations related to barrier options continue to be introduced as shown in Lei [2014]. A Parisian option is also a barrier-type option in which its payment is activated (or deactivated) only if the underlying asset consecutively remains below (or above) a given barrier over a certain amount of time, namely the option window, specified in the contract.…”

Risk Analysis and Hedging of Parisian Options under a Jump‐Diffusion Model

“…However, in recent years, the growth of barrier options has slowed down compared to the fast growth in the early 2000's (see, for example, the report of the Bank for International Settlements (2015) which documents the overall market movements). Nonetheless, new financial innovations related to barrier options continue to be introduced, as shown in Lei (2015). A Parisian option is also a barrier-type option in which its payment is activated (or deactivated) only if the underlying asset consecutively remains below (or above) a given barrier over a certain amount of time, namely the option window, specified in the contract.…”