Listed options are a type of derivative instrument. They give you the right but not the obligation to buy or sell an asset at a fixed price on a set date in future.
A listing exchange is where the buyer and seller meet to complete their transactions involving these financial instruments.
It also lists similar derivatives such as exotic options which differ from standard options in their underlying asset type or other features that require tailored documentation.
It is a derivative contract between two parties. It is an agreement whose terms and conditions are standardized and recorded in a document or electronic screen. The price of the transaction is agreed upon at the time of signing, but payment and delivery may be delayed until later.
In Hong Kong, there are three kinds of listed options.
- European style
- American style and
- Overnight Indexed SIMEX (OIS) options.
Under a European-style option, investors can only exercise their rights at the expiry date while under an American-style option, they can also do it before due to financial situations etc
The last kind is Overnight Indexed SIMEX (OIS) options which is an overnight index swap with the underlying interest rate component replaced by the SIBOR/HIBOR rates. It allows investors to essentially buy or sell the overnight SIBOR/HIBOR rates to lock in future interest earnings.
On the Saxo website listed options can be viewed.
These options are more popular than American-style options since the former have only one exercise date while the latter can be exercised at any time up to its expiry.
Investors will therefore need to exercise their rights for an American style option many times before it expires, increasing transaction costs and management work.
This is why European-style options are traded more frequently on exchanges.
European-style options can be exercised on the expiration date, but American-style options may be traded (sold) any time until the last day of trading.
These options are typically written at a price allowing investors to profit by selling them before their expiration. European-style options are more difficult to write since they cannot be sold before expiration; therefore, premiums will be lower than for an equivalent American-style option.
For both styles of listed options, companies usually sell puts and calls to protect themselves from the risk of interest rate fluctuations or stock market decline respectively.
Large corporations use them as a tool to manage exposure to interest rates while investors use them as a way to invest in bond markets with leverage just like future contracts.
The OIS (Overnight Index Swap)
This market was launched on 23 December 1998 by Hong Kong Exchanges and Clearing Limited (HKEx), to offer overseas investors efficient access to local stock indices (and vice versa).
Unlike traditional stock index futures contracts, which only provide for delivery of their underlier shares upon expiry, OIS allows HKEx to match buy/sell orders on an anonymous basis throughout the life of the contract.
OIS futures are based on overnight interest rates and the term derived is called Overnight Index Swap (OIS). There are two types of OIS, one for HKEx’s Hang Seng China Enterprises Index (HSCEI) and another for Hang Seng Index.
The principle behind OIS is simple: Hong Kong Exchanges and Clearing Limited (HKEx), acting as a clearinghouse between both parties, calculates the difference between an agreed reference interest rate minus an overnight repo rate to determine the cash settlement amount.
The reference interest rate used in this calculation is generally at a constant spread above the overnight repo rate which reflects the cost of borrowing money over that particular time frame.
Listed options are popular in Hong Kong because they provide investors with leverage to gain exposure to bond markets with low risk, unlike future contracts which have a high margin requirement.
They can also be used for more sophisticated purposes such as floating rate debt management.
Last but not least, listed options can also be used in non-standard ways to minimise the cost of borrowing.
By buying a put option with a lower exercise price, companies can repay loans by taking out new ones at the exercise price and using the premium from old puts to cover interest costs. This is known as “floating-rate debt management” or “interest rate collar” and can be a useful tool for risk management purposes.