A warrant is described as in-the-money (ITM), at-the-money (ATM) or out-of-the-money (OTM), depending on the relationship between its strike price and its underlying price.
A call warrant is OTM when its strike price is higher than its underlying price.
It is ITM, when its strike price is lower than its underlying price.
The situation is just the opposite for put warrants.
When its strike price is higher than its underlying price, a put warrant is ITM; and when its strike price is lower than its underlying price, it is OTM.
No matter it is a call or put, if the strike price is equal to the underlying price, the warrant is said to be ATM.
Summary
Call Warrant
ITM Strike Price < Underlying Price
ATM Strike Price = Underlying Price
OTM Strike Price > Underlying Price
Put Warrant
ITM Strike Price > Underlying Price
ATM Strike Price = Underlying Price
OTM Strike Price < Underlying Price
Additional Notes
Call Warrant
An investor can buy a call warrant if he is optimistic about the outlook for its underlying.
When the underlying price does go above the strike price, in theory, the investor can exercise the warrant to buy the underlying at the strike price.
Then he can sell it in the market to earn the difference.
In practice, warrants are traded on a cash settlement basis, and investors will be paid the difference directly.
Put Warrant
In the case of a put warrant, an investor can go for it when he is pessimistic about the market outlook.
If the underlying price is lower than the strike price, in theory, the invstor can exercise the warrant and buy the underlying from the market for delivery to the issuer at the strike price to earn the difference.
In reality, investors will be paid the difference directly.
If it turns out that the underlying price is higher than the strike price, the investor will lose the cost of the warrant.
(The above assumes that the investor will hold the warrant until maturity. Indeed, investors can also "buy low, sell high", and trade warrants just like stocks.)
Showing posts with label call warrant. Show all posts
Showing posts with label call warrant. Show all posts
Thursday, 10 September 2015
Saturday, 1 December 2012
What are the risks in buying call warrants?
Wednesday August 11, 2010
Personal Investing - By Ooi Kok Hwa
Prices are influenced by intrinsic value and time value
Besides, a lot of investors have been complaining that they are unable to make money from the call warrants that they have bought.LATELY, we notice that there are growing numbers of call warrants getting listed on Bursa Malaysia. Even though there are many call warrants issued and traded in the market, the trading volumes of these call warrants are relatively low compared with the normal warrants.
Many investors cannot differentiate between a warrant and a call warrant.
A warrant is a transferable option certificate issued by a company which entitles the holder to buy a specific number of shares in that company at a specific price (or exercise price) at a specific time in the future. It is normally issued by a listed company.
A call warrant (like a call option) also gives investors a right to buy stocks in a company within a fixed period of time. However, warrants are issued by listed companies whereas call warrants are issued by investment banks.
An investor monitoring share prices at a private stock market gallery in Kuala Lumpur. Many investors have been complaining that they are unable to make money from the call warrants that they have bought.
If investors exercise the rights in warrants, they will receive the listed companies’ shares.
Meanwhile, upon maturity of call warrants, investment banks will only pay investors in cash if the closing price of the listed companies is higher than the exercise price of the call warrants. Investors will get nothing if the closing price of the listed companies is lower than the exercise price.
There are many risks in buying into call warrants. Call warrants have shorter maturity period as compared to warrants. Normally, warrants have maturity period of five years or more whereas call warrants have very short maturity period of less than a year.
In many instances, investors who have bought into these call warrants do not realise that their call warrants have expired. Nevertheless, call warrants will be automatically exercised upon the maturity date if the settlement price is higher than the exercise price.
As mentioned earlier, a lot of call warrants are not actively traded in the market. In fact, a majority of them do not have trading volume on a daily basis. We believe one of the possible reasons is that some of these call warrants are getting nearer to maturity date.
The prices of call warrants are influenced by their intrinsic value and time value.
If the call warrants are getting nearer to their maturity date, the time value will be closer to zero. In addition, if the mother price of the listed companies is being traded at a lower price than the exercise price plus the premium that the investors have paid for the call warrant, the market price of these call warrants will fall below their original issue price.
For those who have subscribed into these call warrants, rather than cutting losses and selling them into the market, they will likely hold on to the call warrants and hope that the mother price will recover one day. Unfortunately, in many instances, investors get nothing upon maturity of these call warrants.
Given that the gap between the buying and selling prices is quite big for some call warrants, many investors find it difficult to buy or sell the call warrants. Hence the fact that call warrants usually have low trading volume implies that this is an instrument with very high liquidity risks.
The main reason for a lot of investors to purchase call warrants is the hope of getting payments from investment banks. However, investors need to understand that the majority of the call warrants are European-styled, which means investors cannot exercise them before the maturity date.
The majority of call warrants are settled in cash for the difference between closing price and exercise price. The formula for cash settlement amount is equal to the number of call warrants x (closing price – exercise price) x 1/exercise ratio. Hence, investors need to pay attention to the exercise price, exercise ratio and premium that they have paid.
For example, the exercise price on Call Warrant Company A (Company A CA) is RM10, the exercise ratio is 10 Company A CA to 1 Company A share and the premium investors need to pay is 10 sen for each Company A CA. To the call warrant holders, in order to breakeven, the mother share price of Company A needs to go higher than RM11 or RM10 plus RM1 (10x10 sen, which is the total premium that they have paid).
Lastly, investors need to pay attention to the fundamentals of the mother companies and check the potential price appreciations for these companies.
Companies with good prospects will have higher possibilities of price appreciation and therefore lower risk of buying into the call warrants.
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