Hong Kong retail traders hit by US$1.6 billion wipe-out of popular structured notes

Retail traders in Hong Kong were dealt a blow as US$1.55 billion of leveraged derivatives were called by banks during the recent stock slump, exacerbating market volatility and highlighting the risk of the popular structured product.

Trading in hundreds of mostly bullish contracts was terminated from Jan 17 to 22, exchange data show, causing investors to lose the premium they paid and triggering a rush by banks to unwind their hedge positions. A bulk of the losses happened on Jan 17, when the Hang Seng Index (HSI) posted its biggest decline since October 2022.  

The derivatives, known as callable bull or bear contracts that are sold by the city’s biggest investment banks, allow investors to place leveraged wagers without buying the underlying asset. Their popularity has meant trades related to the securities have frequently been blamed for driving up market volatility in previous routs.

That was what happened in the latest leg of Hong Kong’s stock rout. Some 633 contracts, mostly tied to the HSI, got knocked out in four sessions, according to exchange data.  

Their notional value amounted to more than US$1 billion on Jan 17 alone – one of the biggest knockouts of such contracts over the past year – and nearly US$500 million over the following three sessions, according to calculations by Soujit Ghosh, Bloomberg Apac Lead for Equity Derivatives.  

Investors pay a premium for the contracts, which pay out depending on where the price of the underlying asset settles compared with the strike price on expiry. Should they hit their call price before that, trading is stopped and investors may lose all their original investments.

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Equities in Hong Kong – a majority of which are mainland firms – have been hammered as uncertainties over China’s growth trajectory and Beijing’s policy whims sapped sentiment. While China’s latest attempt to stabilise markets has sparked a rebound, investors remain sceptical whether the gains can last.

Structured derivatives called “snowballs” have also been pointed out as the driver behind volatility in the mainland stock market as gauges tumbled to knock-in levels in recent weeks.

In Hong Kong, the next key trigger level would be 14,700 points, to which 1,369 outstanding bullish HSI contracts are tied as of early Thursday (Jan 25), according to Societe Generale data. That is about 9 per cent lower from current levels.

Hong Kong is the world’s largest market for listed structured products, with their average daily turnover of about HK$11.8 billion (S$2.02 billion) amounting to about 11 per cent of the value traded in the cash market, according to exchange data. BLOOMBERG