If we take into account the extent of difference between the strike price and the underlying price, warrants can be further classified into:
ITM
deep ITM
OTM and
far OTM.
Generally, where there is a 15% or above difference between the strike price and the underlying price, a warrant will be considered far OTM or deep ITM.
However, this 15% mark is merely a rough idea, not an absolute threshold.
One must also look in the volatitlity of the underlying.
Some warrants may be considered deep ITM or far OTM even if the difference between strike price and the underlying price is only 10% or more.
Showing posts with label out of the money. Show all posts
Showing posts with label out of the money. Show all posts
Thursday, 10 September 2015
Warrants - In the money, at the money and out of the money
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.)
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.)
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