Warrants

Questions: Warrants

Question: Let say i have a warrant at 50c and the mother share is $1.50 with exercise price at $1.10..so the premium is 10c.. are we actually banking for the mother share to rise b4 expiry to earn some money? let say b4 expiry it goes up to 2.00, that means we get profit 40c izzit? next, if in betweeen there are any divs and cap repayment of let say 20c...then $1.50 will be adjusted to $1.30 and exercise price will go down from $1.10 to 90c ... am i correct?

Investssmart: Yes, the premium is 10c or 6.7% (10c out of $1.50). That means that the warrant will reach its fair value when the mother share rises 10c or 6.7% to $1.60. Yes, we are banking on the mother share to rise. If the mother share rises 33% or 50c to $2 before its expiry, it is highly likely that the warrant will rise 40-50c as well. Taking into account a gain of 50c for the warrants will equate to a 100% profit. It is amplified by three times because of the 3x leverage ($1.50/50c). IJM-WB offers a leverage of 10x!

You are right on the reduction of exercise price but it will be reduced only when there is a capital repayment. It will not be reduced because of dividends. In other words, the lower the dividend, the better for the warrants. It has to be noted that the time span to expiry is very important for warrants. The longer it is from expiry, the higher should be the premium because longer time will be afforded for the mother share to rise.

Disclaimer: This report is brought to you by Investssmart, an unlicensed investment adviser. Please exercise your own judgment or seek professional advice from your remisiers. By law, they are the experts. I am not responsible for your investment decisions.




Tuesday, March 07, 2006
Comments: Warrants

kchim26 said...
One thing not mentioned here is that, buying warrant, u r betting against time. It is true that warrant can provide leveraging oppotunity, one negative point is that we have limited time on our side. If price go against us, we might lose all our investment in the warrant when it is expired while investing in Mother share will provide us unlimited time to wait for the price to recover.

Conclusion is that, only buy warrant for short term bet, for long term bet, buying mother is better. If we wish to buy warrant to capitalize on higher return, we need to have enough confidence that the company will be performing well before the expiry date. Just my 2cents. ;)

Investssmart: I have to say that I disagree with most of your points. Time is always against warrants but it is not that bad unless your purchase warrants that are way out of money. I recommended earlier in the year YTLPOWR-WA, MTDINFR-WA and ILB-WB. They are all in the money. IJM-WB is just 2% away from being in the money. Warrants actually limit your losses. The important part is not to overexpose yourself. If you would normally purchase 1000 of the company shares, then purchase 2500 warrants at most.

Consider this case: I were to purchase YTLPOWR-WA (expiring 2010 and exercise price $1.43) now at 75c and you were to purchase YTLPOWR now at $2.18. If it drops to just $1 in 2010, I will end up losing all the 75c because the warrants expire out of money. On the other hand, you will lose $1.18.

But you have to remember that I can just purchase these shares from the market at $1 at the time in 2010. That means that both of us are now equal shareholders but your cost stays at $2.18 whereas mine is just $1.75 (75c for warrants+$1 for shares at 2010). Therefore, your statement that mother share is better because it provides unlimited time is not true. Through the warrants, I get the cheaper option as well as the unlimited time by purchasing the shares when the warrants expire out of money.

Of course, you are entitled to dividends as shareholders, but as a warrant holder, I only need to pay a fraction of what shareholders pay. The rest of the money could be used to generate more money by investing in pure dividend stocks. I have to emphasise that warrants are generally undervalued in Malaysia from my experience trading in Australia. Most Malaysian investors do not have a good understanding of warrants. However, it must be noted that we should not purchase warrants that are grossly out of money. I give IJM-WB (2% out of money) an exception because of its long date to expiry, world class management, 10x leverage and low dividend yield.

Disclaimer: This report is brought to you by Investssmart, an unlicensed investment adviser. Please exercise your own judgment or seek professional advice from your remisiers. By law, they are the experts. I am not responsible for your investment decisions.

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