Wednesday June 15 2016

News Source: Global Disclosures

Focus: Position Limits (including MIFID II)

Type: General

Country: Hong Kong




In April 2016, Hong Kong Exchanges and Clearing Limited (HKEX) issued a consultation paper on its proposed revision of the stock option position limit model for its derivatives market. Since the majority of respondents were supportive, HKEX will proceed with the proposal. The features of the proposed three-tier model for stock option position limit are as follows:

  • Three-tier system: A contract equivalent number will be calculated for each stock option class based on the underlying stock’s contract size, market capitalisation and liquidity. Based on the contract equivalent number, each stock option class will be assigned to one of three tiers comprising limits of 50,000, 100,000 and 150,000 open contracts in any one market direction for all expiry months combined.
  • Review mechanism: The position limits for all stock option classes will be reviewed annually and adjusted when necessary to ensure they remain in line with the market’s development. In addition, following a corporate action, the contract size of the affected stock option may also be adjusted to maintain the notional value of the option contract.

As mentioned in the Consultation Paper, the adoption of the proposed three-tier model would require changes to the Securities and Futures Ordinance (SFO) and HKEX’s rules, and is subject to the approval of the Securities and Futures Commission (SFC). Moreover, the SFO changes would need to be introduced to the Legislative Council for negative vetting before the proposed model could be adopted.

With the majority of the responses supportive, HKEX will proceed with its proposed stock option position limit model. The differences of existing and proposed model are summarised below.

Existing Model Proposed Model
Position Limit Tier (contracts) 50,000

30,000

 150,000

100,000

50,000
Methodology on contract equivalent number Higher of (a) or (b):

(a) Lower of (i) or (ii) i) 2.5% of outstanding shares ii) 10% of underlying stock’s turnover over past six months

(b) 7.5% of underlying stock’s turnover over past six months

 5% of outstanding shares, provided that it is not (i) lower than 25% and (ii) higher than 33% of the underlying stock’s turnover over past six months2

 

Subject to an additional threshold3 of 6.7% of underlying stock’s turnover over past six months
Regular Review Mechanism N/A Annual review of position limit tier of each stock option
Adjustment upon Corporate Action N/A Contract size could be adjusted to maintain the notional value of position limit

 

Subject to further discussion with the SFC and SFC’s approval, HKEX’s proposed stock option position limit model to be implemented will be as follows:

Three-tier System

A three-tier system will be introduced for HKEX’s stock option position limit. The position limit would be set with reference to the market capitalization and liquidity of the underlying stocks.

The position limit under the three-tier system is 50,000, 100,000 or 150,000 contracts. If the contract-equivalent number is equal to or higher than 150,000 contracts, the position limit would be set at 150,000 contracts. If the contract-equivalent number is equal to or higher than 100,000 but lower than 150,000 contracts, the position limit would be set at 100,000 contracts. If the contract-equivalent number is lower than 100,000 contracts, the position limit would be set at 50,000 contracts. The tiers are illustrated in the following table.

Tier Contract-equivalent number (X) Proposed position limit*
1 150,000 contracts ≤ X 150,000 contracts
2 100,000 ≤ X < 150,000 contracts 100,000 contracts
3 X < 100,000 contracts 50,000 contracts

 

The contract-equivalent number is calculated based on the number of outstanding shares and turnover of the underlying stocks. It is determined by the followings: 5 per cent of the outstanding shares, provided that it is not:

  • lower than 25 per cent of the stock’s turnover for the past six months;
  • higher than 33 per cent of the stock’s turnover for the past six months.

Otherwise, if 5 per cent of outstanding shares is lower than the 25 per cent threshold, the contract-equivalent number is set at the 25 per cent of the stock’s turnover for the past six months; or if 5 per cent of outstanding shares is higher than the 33 per cent threshold, the contract-equivalent number is set at the 33 per cent of the stock’s turnover for the past six months.

Prudence Measures

The calculation of the contract-equivalent number is subject to an additional liquidity threshold at 6.7 per cent of the past six months’ turnover of the underlying stock if the model is adopted. This is to ensure a smooth transition and prevent speculative positions concentrated in any single expiry month from having an impact on liquidity. The liquidity threshold could be revised from time to time as deemed appropriate by HKEX.

Examples of the calculation of the stock option position limit under the proposed model are shown in the table below.

Examples of HKEX’s stock option position limits under the proposed model
Underlying stock (stock code) Outstanding shares (‘000 contracts) 6-month turnover of underlying shares* (‘000 contracts) Projected contract equivalent number (‘000 contracts) Position limit liquidity threshold Projected contract equivalent number with liquidity threshold (‘000 contracts) Propose d position limit (‘000 contract s)
5% 33% 25% 6.7% of 6m turnover* (‘000 contracts)
Bank of China (3988) 4,181 15,169 11,492 11,492 3,064 3,064 150
Agricultural Bank of China (1288) 154 722 547 547 146 146 100
Cheung Kong Property (1113) 558 480 364 480 97 97 50

 

Review Mechanism

Regular review

Regular review mechanism would be introduced. Reviews will be conducted at the end of each November, and the results will be announced in the following December. If revisions are necessary, they will take effect on 1 April of the following year to provide a buffer for investors to unwind any excess positions.

For corporate action

A mechanism for reviews in connection with corporate actions will be included. Following a corporate action, such as a share split, that affects the underlying stock, HKEX may consider adjusting the contract size of the affected stock option to maintain the notional value of the option contract. Adjustments will take effect immediately on the effective date of the corporate action.

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