Raymond So Wai-man, an associate dean at the Faculty of Business Administration at the Chinese University of Hong Kong, wants tighter rules, arguing that investors' animal spirits are being allowed to run riot at the expense of an orderly market.

'If the crazy warrants trading continues, the stock market could become a retail investor-driven casino,' Mr So said.

That view is controversial in Hong Kong's finance sector, where everyone seems to be a winner in the warrants market: investors can make small fortunes, the stock exchange scoops big fees, brokers earn commissions and issuing banks get to sell a high-yielding product, which, if managed properly, makes them money whether the market rises or falls.

'For the individual investor, the risk is always there, but this is a zero-sum game. If someone makes money, other people will lose money. So, in terms of the market structure, I don't see any problem,' said Jin Zhang, an associate professor at the University of Hong Kong School of Economics.

'These instruments only facilitate the transfer of risk quickly and easily between investors. They do not change the fundamental risk of the whole market.'

Such is the scale of Hong Kong investors' appetite that the local exchange-traded warrants market has in recent years grown into the largest market of its kind (by turnover) in the world.

The number of issued warrants has increased from 840 at the end of last year to 1,183. And, in the past two months, activity has run off the chart with turnover routinely accounting for between 20 per cent and 25 per cent of total daily activity.

Like moths to a light, the number of banks wanting to play in this huge market is growing by the week. In the past week, both UBS and HSBC announced their re-entry, taking the number of issuers to 17. Morgan Stanley and ABN Amro re-entered earlier this year and Goldman Sachs could join the herd before the end of the year.

As with other derivatives, the value of a warrant is linked to the value of an underlying security - typically a single stock or an index - and in theory gives the investors the right, but not the obligation, to buy or sell that security at a fixed price when the warrant expires.

Nowadays, the majority of warrants traded in Hong Kong are cash-settled, which means that no shares change hands on settlement day. Rather, investors are compensated in cold cash for their bet.

Retail investors love warrants because they are liquid, cheap and free of stamp duty. Of late, eager brokers and warrants issuers have waived trading commission fees. Mostly, warrants are loved for the leverage they provide, allowing investors to magnify gains from betting correctly on a particular market direction.

'If you buy Cheung Kong shares, the minimum investment is about $80,000, but if you buy Cheung Kong warrants, it'll cost you only a few thousand. Also, when the underlying share price moves up by 1 per cent, the warrant may gain 5 per cent,' said Chris Lee, the head of intermediary risk management product sales at UBS.

Investors bet on a rising market buying 'call' warrants and benefit from falls in stock prices by purchasing 'put' warrants. Warrants issuers have previously been blamed for exacerbating jarring market ructions since they must buy or sell large amounts of underlying stock to hedge their exposure should the price of that stock move sharply.

For their part, traders argue that such instruments do not so much create risk as spread it around. However, the fact that almost 90 per cent of all outstanding warrants are call warrants means almost everyone is betting that prices will go the same way.

That applies to both warrants issuers and investors, creating potential for a stampede effect in a crash situation when normal hedging activity becomes impossible, leading to panic selling - or for that matter, panic buying in a boom situation.

Adding to the brew is the belief that a majority of investors are day traders who move in and out on a frequent basis.

'They all know the downside of warrants, which can be to give them zero money back, so if they decide to cut losses, they will react a lot faster than investors in the traditional cash market,' one warrants trader said.

Similarly, when investors sell warrants back to issuers, the latter will typically need to sell part of the underlying stock - or, alternatively, futures or options - bought to hedge the exposure.

'When the underlying market moves a lot, warrants issuers also need to keep rehedging and that may increase volatility,' the trader said.

Analysts said such selling - both by investors and warrants issuers - contributed to the sharp correction in the Hang Seng Index on August 18. Similar concerns have been expressed about hedge funds, which have been blamed for exaggerated movement in many different markets over the past few years, most recently in crude oil.

Financial Secretary Henry Tang Ying-yen on Thursday said 'concerns remain that hedge funds, as a group with significant and concentrated exposures, have accelerated volatility especially in markets with thin liquidity'.

In 2002, the exchange overhauled the warrants market, removed pre-listing sales requirements and introduced liquidity providers with the aim of making the market more transparent. This followed a scandal where issuers were found faking the number of investors signed up for an issue, creating a false picture of demand.

'I think the HKEx did a good job when it changed the regulations, because that basically levelled the playing field and introduced a lot more competition, making it fairer to investors,' said an executive at one issuer who declined to be named.

Competitiveness shows in the flood of new products in recent listings. Nine warrants on Bank of Communications were listed on August 1, the first day the stock became eligible for warrants trading. And on Monday, 19 warrants on coal producer China Shenhua Energy will come to the market.

There are now more than 1,200 individual warrants in the market, up from 840 at the end of last year, although not all of those are actively traded.

UBS and HSBC say their foray should be seen as a part of their entire businesses that include selling structured products to institutional and private banking clients. Seen this way, their warrants activity is simply one leg of a multi-legged stool allowing risk to be offset across many products.

In industry parlance, a bank sells volatility when it issues a warrant or an option. It buys exposure when it buys such a product. The game is about balancing risks.

'We have a healthy pipeline of cheap volatility and we make money on the overall volatility management,' Mr Lee of UBS said.

Edmund Lee, a vice-president at SG Securities derivatives department, said the bank, one of the most active warrants issuers in the market, supported the SFC's probe.

'At least, the SFC will give confidence back to investors,' Mr Lee said.

There is a lot riding for many banks and all will be hoping that the probe does not reveal deeper abuses prompting a clampdown. Few will have forgotten the clean-up that followed the 1998 crisis - the last time fears of a system-wide market problem were raised.

Additional reporting by Fiona Lau and Enoch Yiu