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.