Friday, 11 September 2015

Warrants: Conversion Ratio

The conversion ratio determines the number of warrants required for conversion into one share of the underlying stock or one point of the underlying index at maturity.

For example, where the conversion ratio is 10:1, 10 units of warrants will be required to be exchanged for each share of the underlying stock.

Even for warrants with identical terms (same strike price, maturity and implied volatility), their prices may vary hugely.

These warrants are worth exactly the same.  Their prices vary in proportion to the difference in their conversion ratios.

The price of one may be a few cents while the other a few dollars.  This is due to their conversion ratios.

The bigger the conversion ratio, the lower the warrant price.

Conversion Ratio is Insignificant as a performance indicator

Psychologically, investors tend to prefer warrants with a lower face value.

After all, warrants of different price ranges do differ in tick movement.

In theory, the difference in the conversion ratio will not affect the price performance of warrants.

When you are picking a warrant, do not be bothered with insignificant data such as the conversion ratio or premium.  

Unless you want to hold the warrant until maturity, these data should not be a matter of concern.

Rather, to make sure that you are picking the right choice, you should check out carefully the other terms of the warrant, such as implied volatility and effective gearing.

(In calculating the value at maturity and the effective gearing of a warrant at any time, the conversion ratio is always taken into account.)

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