Warrant poser, cash settlement calculation unfair say some

Monday April 30, 2012

By TEE LIN SAY 

linsay@thestar.com.my

PETALING JAYA: The calculation of cash settlement for call warrants has come under the spotlight as some investors argue that the current method is unfair.

They argue that the calculation of cash settlement for call warrants should not be determined based on the average closing price of the last five days, but instead be based on the volume weighted average price of the last five days.

Currently under Bursa Malaysia's listing requirements, issuers of structured warrants are able to determine for themselves the calculation of cash settlement based on three options:

(i) The volume weighted average price; or

(ii) The average closing price; or

(iii) The closing price of the underlying share or exchange-traded fund on the market day immediately before the exercise or expiry date.

However, most issuers presently use the average closing price as the method to determine cash settlement. Some dealers feel that this may be unfair because if the closing price of the mother share gets depressed on the last five days, then the cash settlement figure drops. “This has happened in a few instances, so it raises the question of whether a more dynamic price determination ought to be considered,” said one dealer.

He cited examples of Malaysia Building Society Bhd's (MBSB) call warrants which expired on April 18 and the DRB-Hicom-CH which expired on April 26.

“For the last five days where the price of the mother share was being used to determine the cash settlement, the price of MBSB's mother share was depressed at the close of four out of the five days,” said the dealer.

MBSB-CA expired at 5pm on April 18. Looking at the intraday charts of MBSB on April 11, 12, 13, 16, and 17, the share prices closed at the low of its day for April 11, 12, 16 and 17. The share prices started dropping towards 4.30pm.

For example on April 17, MBSB opened at RM2.19 and reached an intraday high of RM2.25. By 4.30pm, however, the share price had started dropping and it eventually closed (at 5pm) at RM2.17.

Basically, the higher the mother share, the higher the cash settlement for the warrant holder.

The exercise ratio was 3 MBSB-CA for every one MBSB mother share at an exercise price of RM1.48.

MBSB's closing price of RM2.18 was the average of the closing prices for the shares on each of the five market days immediately before the expiry date.

In the case of DRB-Hicom-CH, it expired on April 26. On the last five days of its closing before expiry, which were April 20, 23, 24, 25 and 26, its share price also dipped lower from the RM2.60-RM2.68 range it was trading in the last three weeks. For those five settlement days, the stock closed at an average price of RM2.45.

While it only closed at its intra-day low on April 23, it did close near to its day's low for the other four days.

A Bursa official said that Bursa's current rules were in line with those of other exchanges such as Singapore Stock Exchange (SGX) and the Hong Kong Stock Exchange (HKEX).

“However, in the discharge of our obligation to ensure a fair and orderly market, Bursa Malaysia has and will continue to review the effectiveness of its rules to ensure they meet their intended objectives,” said the Bursa official.

He added that SGX and HKEX allowed for options (ii) and (iii) .

http://biz.thestar.com.my/news/story.asp?file=/2012/4/30/business/11174530&sec=business

Warrants trading: What you need to know

Structured Warrants – Gearing & Greeks

In this article we will look at gearing factor and sensitivity coefficients – the Greeks which measure change in warrant value via change in other variables. 

Gearing & Effective Gearing: Structured warrants cost only a fraction of their underlying shares. They provide holders with greater exposure to price movements as they generally rise and fall more steeply in percentage terms. If a warrant is priced at RM0.30, and the underlying share is trading at RM1.50, the gearing is 5 times. The price of one warrant offers exposure to 5 shares. In bull markets, warrants will always be among the top risers and the opposite holds true in bear markets.

The definition of gearing is: 
Gearing = Share Price / Warrant Price (adjusted by exercise ratio) 

The following chart plots the relative price movements of a call and put warrant against corresponding movements in the underlying share price. Note the percentage change in the value of the underlying share compared with the value change in the call warrant and the put warrant. During a 3-month period, the underlying share price falls by 10% (at Point A) and increases by 8% (at Point B) - share price varies over an 18% range. In contrast, the call warrant fluctuates within a 75% range, while the put warrant fluctuates within an 80% range but in an opposite direction to the call. 
Gearing decreases as the share price increases. 

Delta & Gamma: Delta refers to the rate of change of warrant price for a given change in the underlying share price. For call warrants, the delta will fall between 0 and 1; for puts it will be between 0 and -1. At 0, the warrant is impartial to any moves on the underlying share. At 1, the warrant is expected to move sen-for-sen with the underlying share. Typically, at-the-money warrants will have a delta of 0.5. As the warrant moves in-the-money, the delta will approach 1. 

The most savvy of traders will aim for medium-delta warrants, in the range of 0.4 to 0.5. Any delta too low will denote an out-of-money warrant with strike too far away. 

The delta is a constantly changing number. The rate of change of delta is known as the gamma. One could visualise delta as the speed of the warrant, and gamma as the acceleration. The gamma simulates the changes on the warrant price for different underlying share price. Any move on the underlying share will move the delta higher, as with the gamma. 

Vega: Vega measures the sensitivity of warrant price to change in volatility. Vega is the highest for at-the-money warrants, and tends to be higher for longer-dated warrants. 

With several issuers issuing warrants on the same shares, the belief is that investors and traders should focus on the warrant with the lowest implied volatility. This is only true if the issuers will buy back their warrants at a proportionate volatility level. An example would be buying a warrant at an implied volatility of 45%, which the issuer buys back at 42% versus buying a warrant at a volatility of 40% that is bought back at a volatility of 30%. 

Theta: Also known as time decay, Theta is expressed in terms of sen or percentage per week (or per day closer to expiry). Eventually, the warrant will need to lose the time value entirely. But theta is not linear to time – it will get proportionately larger as it approaches expiry. 

Rho: Rho measures the sensitivity of warrant prices to changes in interest rates. However, the level of interest rates, as a variable, is likely to influence neither warrant pricing nor trading decision making process. 

Final Thoughts: The Greeks do not help answer which warrant to buy. However, they are reliable forecasting tools on the changes in warrant prices versus the underlying share price movements. 


Related:

Warrants trading: What you need to know  Parameters & Variables of Structured Warrants

http://bursaedge.blogspot.com/2012/02/warrants-education-2.html 

Margin of Safety Concept in Conventional and Unconventional Investments

 Extension of the Concept of Investment

To complete our discussion of the margin-of-safety principle we must now make a further distinction between conventional and unconventional investments. 

Conventional investments are appropriate for the typical portfolio. 

• Under this heading have always come United States government issues and high-grade, dividend paying common stocks. 
• We have added state and municipal bonds for those who will benefit sufficiently by their tax-exempt features. 
• Also included are first-quality corporate bonds when, as now, they can be bought to yield sufficiently more than United States savings bonds.

Unconventional investments are those that are suitable only for the enterprising investor. They cover a wide range. 

• The broadest category is that of undervalued common stocks of secondary companies, which we recommend for purchase when they can be bought at two-thirds or less of their indicated value. 
• Besides these, there is often a wide choice of medium-grade corporate bonds and preferred stocks when they are selling at such depressed prices as to be obtainable also at a considerable discount from their apparent value. 
• In these cases the average investor would be inclined to call the securities speculative, because in his mind their lack of a first quality rating is synonymous with a lack of investment merit.

It is our argument that a sufficiently low price can turn a security of mediocre quality into a sound investment opportunity—provided that the buyer is informed and experienced and that he practices adequate diversification. 

• For, if the price is low enough to create a substantial margin of safety, the security thereby meets our criterion of investment. 
• Our favorite supporting illustration is taken from the field of real-estate bonds. 
• In the 1920s, billions of dollars’ worth of these issues were sold at par and widely recommended as sound investments. A large proportion had so little margin of value over debt as to be in fact highly speculative in character. 
• In the depression of the 1930s an enormous quantity of these bonds defaulted their interest, and their price collapsed—in some cases below 10 cents on the dollar. 
• At that stage the same advisers who had recommended them at par as safe investments were rejecting them as paper of the most speculative and unattractive type. 
• But as a matter of fact the price depreciation of about 90% made many of these securities exceedingly attractive and reasonably safe—for the true values behind them were four or five times the market quotation.*

The fact that the purchase of these bonds actually resulted in what is generally called “a large speculative profit” did not prevent them from having true investment qualities at their low prices. 

• The “speculative” profit was the purchaser’s reward for having made an unusually shrewd investment. 
• They could properly be called investment opportunities, since a careful analysis would have shown that the excess of value over price provided a large margin of safety. 
• Thus the very class of “fair-weather investments” which we stated above is a chief source of serious loss to naive security buyers is likely to afford many sound profit opportunities to the sophisticated operator who may buy them later at pretty much his own price.†

The whole field of “special situations” would come under our definition of investment operations, because the purchase is always predicated on a thoroughgoing analysis that promises a larger realization than the price paid.  Again there are risk factors in each individual case, but these are allowed for in the calculations and absorbed in the overall results of a diversified operation.

To carry this discussion to a logical extreme, we might suggest that a defensible investment operation could be set up by buying such intangible values as are represented by a group of  “commonstock option warrants” selling at historically low prices. (This example is intended as somewhat of a shocker.)* 

• The entire value of these warrants rests on the possibility that the related stocks may some day advance above the option price. 
• At the moment they have no exercisable value. 
• Yet, since all investment rests on reasonable future expectations, it is proper to view these warrants in terms of the mathematical chances that some future bull market will create a large increase in their indicated value and in their price. 
• Such a study might well yield the conclusion that there is much more to be gained in such an operation than to be lost and that the chances of an ultimate profit are much better than those of an ultimate loss. 
• If that is so, there is a safety margin present even in this unprepossessing security form. 
• A sufficiently enterprising investor could then include an option-warrant operation in his miscellany of unconventional investments.1

* Graham is saying that there is no such thing as a good or bad stock; there are only cheap stocks and expensive stocks. Even the best company becomes a “sell” when its stock price goes too high, while the worst company is worth buying if its stock goes low enough. 

† The very people who considered technology and telecommunications stocks a “sure thing” in late 1999 and early 2000, when they were hellishly overpriced, shunned them as “too risky” in 2002—even though, in Graham’s exact words from an earlier period, “the price depreciation of about 90% made many of these securities exceedingly attractive and reasonably safe.” Similarly, Wall Street’s analysts have always tended to call a stock a “strong buy” when its price is high, and to label it a “sell” after its price has fallen—the exact opposite of what Graham (and simple common sense) would dictate. As he does throughout the book, Graham is distinguishing speculation—or buying on the hope that a stock’s price will keep going up—from investing, or buying on the basis of what the underlying business is worth.

* Graham uses “common-stock option warrant” as a synonym for “warrant,” a security issued directly by a corporation giving the holder a right to purchase the company’s stock at a predetermined price. Warrants have been almost entirely superseded by stock options. Graham quips that he intends the example as a “shocker” because, even in his day, warrants were regarded as one of the market’s seediest backwaters. (See the commentary on Chapter 16.)

Ref:  The Intelligent Investor by Benjamin Graham

CHAPTER 20 “Margin of Safety” as the Central Concept of Investment



Also read:

• Margin of Safety Concept in The Business Venture of Buying and Selling Stocks
• Margin of Safety Concept in Conventional and Unconventional Investments
• Margin of Safety Concept in Speculation and Investment
• Margin of Safety Concept in Diversification
• Margin of Safety Concept in Undervalued or Bargain Stockss
• Margin of Safety Concept in Growth Stocks
• Margin of Safety in Good-Quality and Low-Quality Stocks.
• Margin of Safety Concept in Common Stocks
• Margin of Safety Concept in Bonds and Preferred Stocks

Comparing Warrants: Learning from Alan Voon, the Warrant Specialist

PBBANK Warrants Comparison

Written by Alan Voon

Saturday, 18 July 2009 12:27

The share price of Public Bank has been rising significantly since the beginning of July 2009.  From a price of about RM9.00 in early July, the share price of Public Bank has risen more than 12% to RM10.10 at the closing on July 17 2009. Public Bank is expected to announce its half year results soon and investors who wish to speculate on further upside of Public Bank upon announcement of its results can consider the call warrants of Pulblic Bank that are listed on Bursa Malaysia.  There are three Public Bank call warrants which are still trading in Bursa Malaysia now.  There are PBBANK-CH and PBBANK-CJ issued by CIMB and PBBANK-CK issued by OSK.  With the exception of PBBANK-CH which is an American style warrant, the two other warrants are European style where holders can only exercise the warrants on expiry.  The following tables are the prices and indicators of all three Public Bank warrants. PBBANK-CH PBBANK-CJ PBBANK-CK Warrant Price (RM) : 0.03 0.61 0.195 Underlying Share Price (RM) : 10.10 10.10 10.10 Exercise Ratio : 10 4 8 Exercise Price (RM) : 9.85 7.50 8.80 Expiry Date : 3/9/2009 29/9/2010 7/4/2010 Premium : 0.50% -1.58% 2.57% Gearing : 33.67 4.14 6.47 Underlying Historical Volatility : 15% 15% 15% Implied Volatility : 12% 27% 31% Delta : 0.70 0.80 0.70 Effective Gearing : 23.6 3.3 4.5 From the table above, we note that PBBANK-CJ is actually trading at a slight discount.  Is there an arbitrage opportunity for Public Bank shareholders? The answer is no because this is an European style warrant and its holder cannot exercise the warrant immediately.  Given the generous dividend payout of Public Bank in the past and expected in the near future, PBBANK-CJ holder will lose out by not getting any dividend benefit and hence it is trading at a discount although a very small one.  If you plan to hold PBBANK-CJ until expiry, there is actually no discount because the expected annual dividend yield of Public Bank is closer to 5% and the warrant has more than one year to expiry. For punters who wish to punt on results rally, PBBANK-CH is the best choice of the three due to its much higher effective gearing and low implied volatility.  Based on an effective gearing of 23.6 times, if the mother share rises 10%, the warrant should rise 2.36 times in theory.  This warrant has just become in the money after the big rise in mother share the last few weeks and is now the most attractive punt of the three warrants.  However, it can also be the riskiest if Public Bank share drops back soon on possible correction.  If the retracement is substantial and the mother share drops below the exercise price, holder of PBBANK-CH may not have enough time to recapture intrinsic value since the warrat is expiring in a little more than 1 month.  High Risk High Gain! PBBANK-CK is probably the least favoured.  Its valuation is not excessive but in terms of premium and implied volatility, it is the most expensive of the three. Alan Voon Warrants Specialist alan@warrantscapital.com July 18 2009 This article is for information and education only.  It is not a recommendation to buy or sell any securities mentioned in the article. Please exercise your own judgment or seek professional advice for your specific investment needs. We are not responsible for your investment decisions. Our shareholders, directors and employees may have positions in any of the stocks mentioned. http://www.warrants.com.my/english2/index.php?option=com_content&view=article&id=74:pbbank&catid=42:articles-3month

Warrants trading: What you need to know

These cheap investment tools were virtually non-existent in Singapore a few years ago, but a recent growth spurt has sent their popularity soaring. Let's look at reasons to invest in warrants and how to go about it.
IF THE experts are right, the current boom in this investment tool is far from petering out.

They say more and more market traders are jumping in, as well as investors looking beyond stocks and bonds to bolster their portfolios.

To get an idea of just how popular they have become, consider this: Warrants turnover on the Singapore Exchange has grown from zero in 2003 to about $3 billion a month now.

The number of active warrant accounts has also shot up more than tenfold, to 20,154 this June from 12 months earlier.

A key attraction of warrants is that they are cheap.

Warrants trade around 20 cents to 30 cents, so the minimum investment for one lot - 1,000 shares - could be as low as $200 to $300.

As with any instrument, money can be made and lost when trading warrants.

For example, say an investor bought a call warrant on stock X for 30 cents with an exercise price of $5. Also, assume the conversion ratio is one to one, which means one warrant can be converted into one share.
The current share price is $5.25.

If the investor holds the warrant to maturity and exercises it, he is effectively paying $5.30 apiece for the shares (30 cents warrant cost plus $5 exercise price).

If the price of stock X stays at $5.25, he will get back 25 cents, so effectively, he will lose five cents ($5.30 minus $5.25).

If the share price falls to $5 or below, he will lose just his investment capital of 30 cents, but no more, even if the share price falls drastically.

On the other hand, if the stock's market price shoots up to $5.35, converting the warrant into a share would mean a five cent profit.

Consultant Peter Ang, 32, started trading warrants this year with a principal sum of $15,000. He made a 25 per cent return in just three days, after he bought DBS Group Holdings and CapitaLand warrants in September. But he lost about $20,000 in two weeks when the stock market nosedived recently. 'I wasn't careful, so I didn't cut my losses fast enough,' he said.

Despite the spectacular growth in the Singapore warrants market, Hong Kong is still well ahead because of a flood of China listings there.

Previous attempts to launch warrants trading here in 1995, and again in 1999, tanked for various reasons - including overly stringent listing rules and inadequate investor education.  

But three years ago, warrant issuers - some of the biggest players include Deutsche Bank, Macquarie Bank, Societe Generale and BNP Paribas - started to double as market makers. This means these banks provided buy and sell prices on warrants to ensure that investors had the chance to enter or exit the market.  They also embarked on investor education seminars and dedicated websites featuring trading tools.


How to pick a suitable warrant?


Directional view
Without getting bogged down in technical terms such as 'implied volatility', you should consider one factor when picking a warrant: whether you think the underlying asset is likely to go up or down in value.
Your view will determine whether you select a call warrant or a put warrant.
For example, suppose the Government has announced a new project and the likelihood of CapitaLand securing the project is high.
If you think this is good news for CapitaLand, you could consider buying call warrants on the stock - since you would expect the stock price to rise.
But if you think CapitaLand's share price is more likely to fall, you might want to buy a put warrant.
'Theoretically, if one has a neutral view on a stock, it would not be advisable to invest in warrants,' Deutsche vice-president Sandra Lee cautioned.

Timing
You also need to factor in the timeframe - and be confident that the underlying asset price is set to reach your price target at the same time that the warrant matures.
Take a call warrant, for example. The longer the time to expiry, the more time there is for the underlying asset to appreciate, which in turn will increase the price of the call warrant.
A call warrant that is far 'out-of-the money' with very little time to expiry is considered highly risky. This is because it has an exercise price that is much higher than its underlying price and yet has little time to appreciate.
In contrast, when the call warrant's exercise price is lower than its underlying price, the warrant is regarded as 'in-the-money'.
For both call warrants and put warrants, if the exercise price is equal to the underlying price, the warrants are said to be 'at-the-money'.
'If you believe the market is going to have a sharp correction soon, you should choose a short-term out-of-the- money put warrant,' said Mr Simon Yung, BNP's head of retail listed products sales for Singapore and Hong Kong.
'If you expect a stock to move up gradually in one to two months' time, you should choose a mid-term at-the- money or a 1 to 5 per cent out-of-the- money call warrant.'


Why invest in warrants?
Gearing effect
The biggest advantage warrants trading has over stocks trading is the gearing effect, which means that you can make huge gains from a modest investment outlay.
For example, it can cost nearly $20,000 to buy one lot of DBS shares (assuming a market price of $20 a share).
An increase of 1 per cent in the DBS share price will give you a return of $200.
But if you buy a DBS warrant with an effective gearing of 10 times, it should roughly return the same profit of $200.
The effective gearing indicates roughly how many per cent a warrant price will move if the underlying stock changes by 1 per cent.
In this case, trading in the DBS warrant costs just $2,000 but reaps the same $200 return.
'If the share price moves in your favour, you will get higher returns with a higher level of gearing. But if you get your view wrong, losses will also be greater,' said Mr Barnaby Matthews, Macquarie's head of warrants sales.
Since warrants are typically cheaper than underlying shares, this potentially frees up investors' cash for other purposes.

A hedging tool
Buying a put warrant - which gives you the right to sell the underlying asset later - is like buying an insurance policy for your portfolio, as it protects you from falls in the market.

'If the underlying asset declines, then put warrants will appreciate in price to offset losses suffered by the underlying asset,' said Mr Ooi Lid Seng, Societe Generale's vice-president of structured products for Asia ex-Japan.

For example, one can hold OCBC Bank shares and buy OCBC put warrants. If the OCBC share price keeps falling, losses will be partially offset by the gain in the put warrant price.

As warrants can be used to capture both the upside (call warrants) and the downside (put warrants), they can be used as a tool for risk management in a stock portfolio.

Mr Yung said that warrants can be a perfect instrument for balancing a portfolio's risk profile. 'A portfolio with only bonds, property and stock may not be able to optimise the risk-taking capability of the investor,' he said.


Tips on investing

FIRST, investors should never invest all their investment capital in warrants.

'Generally, we do not advise them to invest more than 10 per cent of their total investment capital in warrants due to the high-risk and high-return nature of warrants,' Mr Ooi said.

Retirees should also not use retirement funds needed to maintain their lifestyle to invest in warrants, as they generally have a lower risk tolerance, he added.

Investors should also be disciplined about taking profits and cutting losses. Mr Matthews advised investors to monitor their positions closely as warrants tend to move in greater percentage terms than shares.
Customer service manager Jason Kua, 37, would know. Three weeks ago, he lost about $25,000 in just two weeks after trading in some Straits Times Index warrants.

'Greed made me lose a lot. I was hoping my initial losses could be recovered, but this didn't happen,' he said.
Finally, investors should attend a seminar or do some reading to ensure that they understand the product before investing.

'Asking the expert before you invest is always a good idea,' Mr Yung said.
--------------------------------------------------------------------------------
What is a warrant?

WARRANTS are 'derivative' investment products - that is, they derive their value from an underlying asset such as a stock or a market index such as the Straits Times Index.
They give the investor the right to buy or sell the underlying asset from the issuer by paying a specific 'strike' or exercise price within a certain timeframe.
A call warrant gives the holder the option to buy, while a put warrant gives the option to sell.
Take a Keppel Corp call warrant for example.
If the price of the underlying Keppel stock rises above the exercise price before the expiry of the warrant, it will clearly be to your advantage to exercise the right to buy Keppel shares.
If you plan to exercise the Keppel warrant - that is, convert it into a Keppel share - you must do so before the expiration date. Of course, if Keppel's price stays below the exercise price, the warrants will expire worthless.


But investors often do not have to hold warrants to maturity. Normally, they simply buy and sell warrants on the stock market as they move in line with movements in the underlying share price.


'Warrants, unlike shares, have a finite lifespan,' said Deutsche Bank vice-president Sandra Lee. 'For each day the investor holds on to the warrant, the warrant loses some time value.'

Warrants usually have three- to six-month expiry dates.


http://www.asiaone.com/Business/My+Money/Building+Your+Nest+Egg/Investments+And+Savings/Story/A1Story20071205-39670.html