Hong Kong stock market investors had the very first taste of a closing auction yesterday, spurring some concerns over the trading of callable bull/bear contracts (CBBCs) among market participants.

According to figures provided by the HKEx, turnover during the first closing auction was approximately HK$2 billion, with close to 6,000 trades.

Market watchers agreed that the debut session went off "smoothly", however noted that auctioning was not very active. UBS Executive Director and Head of Warrants Johnny Yu attributed the lukewarm activity to unfamiliarity of how the closing auction works.

"Most people know that a closing auction will commence, but have yet to develop a clear sense of how it actually functions," Yu said. For instance, Yu said some clients did not know that unlike normal trading period where investors can track the index's movement real time, no intermediary index figure will be announced during the auction period.

Within the 10-minute closing auction, which kicks in immediately after the normal continuous trading period that ends at 4:00pm, traders will be able to enter sell and buy orders for specific shares. A single closing price will then be determined after all the orders were consolidated.

Although the practice is internationally recognized to provide a more market-sensitive closing price, some are concerned that this will impact the trading of CBBCs.

"If the stop loss limit is triggered during the closing auction, not only are investors unable to sell before it terminates, but it could also affect how the remaining value of the CBBC is calculated," Yu said.

CBBCs are derivatives that track the performance of underlying assets of either an index or a particular share. A special feature of the product is its mandatory call feature - meaning the trading of the product will be terminated once the value of the assets breaches or equals to the original call price before expiry date.

This caps the loss of investors to the initial investment amount.

However, director of ABN Amro's private investor products, Ivan Ho, believes the impact of the new auction system to be mild. "If investors decide to hold on to the CBBC that is hovering close to the call price, mandatory termination of the contract should be within expectation," Ho said.

Ho, on the other hand, reminds that investors should be more cognizant about the closing auction's impact on the implied volatility of warrants.

"If the closing auction price dips further than the nominal close, the implied volatility could go up for call warrants," he added.

(HK Edition 05/27/2008 page2)