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Hong KongTraded options on SEHK: the basics that get examined
A traded option on SEHK gives its buyer a right, not an obligation, to buy (call) or sell (put) the underlying at a set price. The buyer pays a premium and risks only that premium. The writer takes on the obligation, receives the premium, posts margin and carries the exposure. SEOCH clears.
One asymmetry runs through every option question on this paper. The buyer has a right. The writer has an obligation. Get that the wrong way round and you will fail questions you otherwise understand perfectly.
- Instrument
- Exchange-traded stock options on SEHK
- Clearing house
- SEOCH - the SEHK Options Clearing House
- Buyer's position
- Right without obligation; pays premium; maximum loss is the premium
- Writer's position
- Obligation without right; receives premium; posts margin; carries the exposure
- Standardised terms
- Underlying, contract size, strike price, expiry, exercise style
What is a call and what is a put?
| Call option | Put option | |
|---|---|---|
| Buyer's right | To buy the underlying at the strike price | To sell the underlying at the strike price |
| Buyer profits when | The underlying rises above the strike, beyond the premium paid | The underlying falls below the strike, beyond the premium paid |
| Writer's obligation | To deliver, or settle, if exercised against | To take delivery, or settle, if exercised against |
| Writer's maximum gain | The premium received | The premium received |
| Who posts margin | The writer | The writer |
Four combinations exist: buy a call, buy a put, write a call, write a put. Questions almost always describe one of the four in words rather than naming it, so translate the stem before you look at the options.
Why does only the writer post margin?
Because margin exists to cover future obligations, and the buyer has none. Once the premium is paid, the buyer can walk away. Nothing more can be demanded of them, so there is nothing for the clearing house to collateralise.
The writer is in the opposite position. Having taken the premium, the writer may be called on to deliver stock or to buy stock at a price that has moved badly against them. That contingent liability is what margin secures, and it is revalued as the market moves.
The buyer's maximum loss is the premium. The writer of a put faces loss down to a zero underlying price. The writer of an uncovered call faces theoretically unlimited loss. If an answer option says the option buyer can lose more than the premium, it is wrong.
What are the standardised contract terms?
Exchange-traded options are not negotiated between the parties. The Exchange fixes the underlying stock, the contract size, the available strike prices, the expiry months and the exercise style, and traders choose from the series on offer. Standardisation is what makes the contracts fungible, which is what makes a liquid secondary market possible.
Contrast that with an over-the-counter option, where terms are bespoke and the parties carry each other's credit risk. The distinction between exchange-traded and over-the-counter instruments shows up across several topics, so it is worth having ready.
How do exercise and assignment work?
The buyer exercises. The clearing house then assigns the resulting obligation to a writer. Assignment is not a matter of the buyer choosing which writer to pursue, because the buyer's counterparty is the clearing house, not another trader.
That is the second thing SEOCH does, and it matters as much as the first. By becoming the counterparty to both sides, the clearing house removes the need for either party to assess the other's creditworthiness. A writer who defaults is SEOCH's problem, not the buyer's.
Options against futures, in one table
| Option | Futures contract | |
|---|---|---|
| Obligation | One-sided: only the writer is bound | Two-sided: both parties are bound |
| Payment at inception | Buyer pays a premium | No premium; both post initial margin |
| Margin | Writer only | Both parties |
| Buyer's maximum loss | The premium | Not limited to any initial payment |
| Clearing (Hong Kong) | SEOCH for SEHK stock options | HKCC for HKFE futures |
Read that table twice and you have most of what Topic 7 asks about derivatives. The futures side fills in the margin mechanics.
A worked question
A client writes a call option over a listed stock and receives a premium. The share price then rises sharply above the strike price. Which statement is correct?
- The client's maximum loss is the premium received
- The client may choose not to perform, because an option confers a right rather than an obligation
- The client is obliged to perform if exercised against, and the loss is not capped at the premium
- The client must post additional premium to the clearing house
How much depth is needed?
Very little pricing, quite a lot of structure. Paper 1 is a regulation paper, not a derivatives paper, so nobody is going to ask you to value an option. What you need is the rights-and-obligations grid, the margin logic and the clearing arrangement.
An honest caveat: candidates who have traded options find this heading trivial and can skip it. Candidates who have not sometimes over-invest, trying to understand time value and volatility because the textbook mentions them. That is not where the marks are. Learn the four positions, learn who is exposed, and spend the recovered hour on Topic 9.
Common questions
What is the difference between an option buyer and an option writer?
The buyer holds a right without an obligation, pays a premium and cannot lose more than that premium. The writer holds an obligation without a right, receives the premium, posts margin, and carries exposure that is not capped at the premium.
Why does the option buyer not post margin?
Margin secures future obligations, and the buyer has none once the premium is paid. The writer may be required to deliver or take delivery of the underlying at an unfavourable price, so the clearing house collateralises that contingent liability instead.
Which clearing house handles SEHK stock options?
SEOCH, the SEHK Options Clearing House. It becomes the counterparty to both sides, assigns exercised options to writers, and removes the need for either party to assess the other's creditworthiness. HKCC clears HKFE futures and options.
What is the maximum loss on a written put option?
The writer of a put may have to buy the underlying at the strike price however far the market falls, so the loss runs down to a zero underlying price, less the premium received. It is large but finite, unlike an uncovered written call.
Are exchange-traded options negotiated between the parties?
No. The Exchange standardises the underlying, contract size, strike prices, expiry months and exercise style, and traders select from the available series. Standardisation makes the contracts fungible and supports a liquid secondary market, unlike bespoke over-the-counter options.