The average monthly turnover for warrants in the first half of this year has rallied to a relatively healthy $482 million.
Tue, Jul 20, 2010
my paper
BY REICO WONG
THE warrants market in Singapore is seeing a pickup in activity, as investor interest in these high-risk, high-return investment options rebounds in line with the global economy recovery.
According to data provided by Societe Generale (SG), a major issuer of warrants in Singapore, the average monthly turnover for warrants in the first half of this year has rallied to a relatively healthy $482 million.
Experts added that the current 1.5 per cent ratio of warrants to overall market turnover - while still low compared to those during periods of economic boom - indicates that investor confidence is slowly improving.
There has also been a strong return in demand specifically for stock warrants in the past six months, according to Mr Barnaby Matthews, the head of derivatives at Macquarie Capital Securities. "It is normal during times of high uncertainty and volatility for investors to favour index warrants - which was the case for most of last year," he said.
"Now that confidence is returning to the market, investors have become more active in single-stock warrants, which have contributed almost 40 per cent to warrants turnover in each of the last two months."
He added that the size of outstanding positions in warrants that investors are holding onto is growing.
"This shows that investors are taking on more risk and are confident enough to hold positions," said Mr Matthews.
Experts pointed out that investors are typically drawn to warrants because the instruments allow them to gain exposure to an underlying security without actually owning it. Also, investors can easily trade the highly liquid warrants on the Singapore Exchange, just as they can for shares.
More importantly, warrants cost only a fraction of the price of their underlying security. Investors are thus able to trade more warrants than the underlying shares for the same outlay in investment.
Because the unit prices of warrants are low, they offer a high level of gearing to investors. Warrants generally exaggerate share-price movements in terms of percentage change.
For example, if share ABC rises by $0.30 per share, from $1.70 to $2, the percentage gain would be about 18 per cent.
But a $0.30 gain in a warrant, from $0.70 to $1, would translate into a 43 per cent gain.
The gearing factor here would therefore be 2.43 (calculated by dividing the original share price by the original warrant price after multiplying it by the share conversion ratio). This figure also indicates the amount of financial leverage the warrant offers.
The higher the gearing factor, the larger the potential for capital gain. This works to the investor's advantage, especially if his outlook for the underlying share is very bullish.
However, investors must note that gearing is a double-edged sword. The 43 per cent gain shown in the earlier example could just as easily become a loss and cause substantial damage to a portfolio.
"Selecting warrants with an appropriate gearing level and deciding how much of their portfolio to invest in warrants are two key areas that Singaporean investors could improve on," said Mr Matthews.
Investors also need to look beyond gearing if they are not trading warrants in just the short term, said Mr Edmond Lee, director of Global Equity Flow at SG Securities.
"If you target a longer uptrend or downtrend, gearing cannot be used as a reference because it doesn't take into account implied-volatility changes and time-decay factors," he said.
Implied volatility - the expected volatility of the underlying share in a given future period of time - is a critical factor to consider when selecting a warrant, as it is related positively to the warrant price.
Usually, the higher the implied volatility, the higher the value of the warrant, so it is generally recommended that investors pick warrants with lower implied volatility.
Also, unlike shares, warrants are decaying assets. Investors have limited time to exercise their rights on the warrants, before they expire and become worthless.
Ultimately, investors need a complete understanding of all parameters affecting the performance of warrants before they start trading such instruments.
Up-to-date and reliable information about markets and the underlying shares is also important.
Mr Matthews added that it is critical for investors to set "stop loss" and "take profit" price targets, just as they would for other investments.
"If you are disciplined when investing with warrants, your chances of success will increase exponentially," he said.
WHAT ARE WARRANTS?
IN FINANCIAL circles, warrants are an investment opportunity which typically arise as part of a new bond issue, but are traded separately from the mother stock.
Considered a security, warrants allow investors to bet on the value of the issuing firm's shares, whether it will rise above or fall below the prevailing market price, at a specified future date.
The price of a warrant thus reflects the value of the underlying stock but are more volatile.
Investors should note that warrants come with an expiry date. The more time remaining before the warrant expires, the more time for the price of the underlying stock to appreciate, which, in turn, will increase the price of the warrant (unless other factors cause it to depreciate).
TYPES OF WARRANTS:
Warrants typically fall into two main categories: American-style warrants, which allow investors to exercise their right at any time during the life of the warrant; and European-style warrants, where the rights can be exercised only on the expiry date itself.
Most warrants in Singapore are European-styled.
Within the warrant market, call warrants represent a specific number of stocks that can be purchased from the issuer at a specific price, on or before a certain date. Investors will buy this if they believe the underlying stock price will rise.
On the other hand, a put warrant represents a certain number of shares that can be sold back to the issuer at a specified price, on or before a stated date. Investors will buy such warrants when they believe the price of the underlying stock will fall.
For a call warrant, when the underlying asset price is higher than the warrant strike price, it is in-themoney - intrinsic value is greater than 0.
If the underlying price is equal to the strike price, it is at-the-money. If the underlying price is lower than the strike price, it is out-of-the-money - no intrinsic value.
For a put warrant, when the underlying asset price is lower than the warrant strike price, it is in-the-money - intrinsic value is greater than 0.
If the underlying price is equal to the strike price, it is at-the-money. If the underlying price is lower than the strike price, it is out-of-the-money - no intrinsic value.
INTERPRETING THE WARRANT
NAME: STI 2450 DBePW081201
Underlying asset: STI
Strike Price: 2450
Issuer: Deutsche Bank
Warrant Type: e (European type)
Warrant Class: PW (put warrant), CW (call warrant)
Expiry date: 081201 (Dec 1, 2008)
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