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Monday, September 3, 2012
A structured warrant is a financial instrument issued by third-party financial institutions, usually banks. Structured warrants offer investors an alternative avenue to participate in the price performance of an underlying asset at a fraction of the underlying asset price, in both bullish and bearish markets.
Benefits of Trading Structured Warrants
• Leverage – Warrants allow investors to gain exposure to an underlying asset at a fraction of its price. For the same investment outlay, a warrant provides an increased exposure to the underlying asset and this magnify the returns available.
• Limited downside losses – The maximum potential loss is limited o the total amount paid of the warrants, which is a fraction of the underlying asset. Potential gains, however, are unlimited for call warrants.
• Access to diverse markets – Warrants provide investors alternative avenues to participate in local and foreign-listed equities, basket of shares (e.g. ETF) or indices.
• Cash extraction – Investors can free up capital by buying the call warrants instead of the underlying assets and yet maintain an equivalent level of exposure to the underlying assets.
• Portfolio protection - Put warrants can be used to protect against a decline a portfolio’s value. This is known as hedging.
• No margin calls – Unlike other derivatives like Contract for Difference (“CFD”) or Options, warrant investors do not have to make a cash top-up if the underlying assets move adversely.
• Liquidity – All warrants listed on SGX have market makers to provide continuous bid and ask prices. Investors can buy and sell warrants anytime during market hours.
Key Factors that Determine a Warrant Price
The price of a warrant is derived using option pricing models such as the Black-Scholes. There are six factors that affect a warrant price. The effects of each factor on both call and put warrants are detailed below
Change in Warrant Price
Underlying Asset Price Increases
An upside movement in the underlying asset makes a call warrant more valuable and a put warrant less valuable.
Exercise Price of Warrant Increases
A high exercise price reduces the probability of a call warrant being exercised and increases the probability of a put warrant being exercised.
Implied Volatility of Underlying Asset Increases
The higher the price fluctuation of the underlying asset, the greater the potential for the structured warrant to trade in-the-money.
Lifespan of Warrant Decreases
The value of a warrant declines as the warrant’s lifespan becomes shorter.
Divided Yield of Underlying Asset Increases
Cash payments on the underlying asset tend to decrease the value of a call warrant because it makes it more attractive to hold the underlying asset than the optionality.
Interest Rates Increases
Interest rates affect a warrant price through the holding costs of buying the underlying assets to hedge the warrants sold. As interest rate increase, the value of the call warrant increases and the value of the put warrant decreases.
Types of Warrants Offered on SGX
Warrants listed on SGX are primarily European-style and may only be exercised on the expiry date. At expiry, the settlement of the warrants is usually made in cash rather than a purchase or sale of the underlying asset.
A Bullish View of the underlying asset
A Bearish View of the underlying asset
Rights of Warrant Holders
Holders have the right, but not the obligation, to buy the underlying assets from the issuer at a predetermined exercise or strike price on the expiry date
Holders have the right, but not the obligation, to sell the underlying assets to the issuer at a predetermined exercise or strike price on the expiry date
Warrants have an average lifespan of 3 to 9 months. Warrants are also offered with longer tenure between 1 to 3 years.
Settlement if warrants expire in-the-money
Cash settled if the settlement price is above the exercise price
Cash settled if the settlement price is below the exercise price
Total investment outlay
Risks to Consider before Trading Structured Warrants
• Limited lifespan – Unlike the underlying asset, warrants have a limited lifespan and will expire. If they expire at-the-money or out-of-the-money, investors holding onto these warrants will lose their entire investment capital used to purchase the warrants.
• Leverage – Being geared instruments, returns can be magnified if the underlying asset moves in the direction favourable to the warrant-holder’s view. However, losses can also be high if the underlying moves against the warrant-holder’s view.
• Issuer risk – Warrant holders are unsecured creditors of issuers. They have no preferential claim to any assets that an issuer may hold in the event the issuers are unable to fulfill their obligation.
• Currency risk – If the price of the underlying asset is denominated in a foreign currency, investors will be exposed to foreign exchange rate fluctuations.
• Market risk – The market value of a warrant is susceptible to other prevailing market forces including the demand and supply of the warrants.
• Suspension from Trading – Trading of warrants will be halted or suspended if the underlying stock is halted or suspended. Warrants investors will not be able to unwind their positions in such circumstances.
Please visit www.sgx.com/warrants for more information on SGX-listed structured warrants or download the Investor Guide to Structured Warrants.
Posted by starone at 11:25 AM