The basic concept of warrants is to give investors the right to buy or sell the underlying at the pre-determined strike price on the pre-determined date.
Company Warrants are issued by companies to raise funds or to reward employees or shareholders.
Upon maturity of a Company Warrant, provided that the stock price is higher than the strike price at the time, the holder is entitled to buy a certain number of shares of the company at the strike price.
When the holder does exercise the warrant, the company must issue new shares to meet the promise.
So, when Company Warrants are exercised, the shareholding of the company will be diluted.
Company Warrants normally have lower liquidity, and there is no way to compare their prices.
This is because the price of a Company Warrant is mainly determined by the board of directors.
Therefore, the warrant price is very likely to deviate from the underlying price.
Put another way, Company Warrants are less transparent and, sometimes, more speculative.
Investors should study the relveant information carefully and bear in mind their own risk tolerance in making the decision whether to invest in Company Warrants.
Showing posts with label warrants. Show all posts
Showing posts with label warrants. Show all posts
Thursday 10 September 2015
Warrants versus Stocks
If you are optimistic about a stock, the most direct investment strategy is to buy the stock.
However, some investors may choose to buy a related warrant instead.
Pros: Limited investment amount.
The biggest advantage of warrants is the leverage effect, which allows you to invest with less capital for the same return, as compared with stock trading.
The lower capital required for warrants means that, in case there is a market downturn, the loss will be limited as compared with investing directly in the stock.
In fact, in a number of major setbacks in the past, even giant blue chips fell sharply. Buying warrants instead of stocks can help minimize one's exposure to such market risks.
Cons: Time constraint
Of course, warrants are not without their shortcomings.
It takes a lot of time to understand the factors that may affect warrant prices before one can master the leverage effect to one's advantage.
Investors must get to know that warrants are subject to the time constraint.
The price of a warrant may change along with the implied volatility and dividend payout of its underlying and interest rates.
Even if you get the underlying direction right, you may still fail to reap the expected return.
In case you get it wrong, you should stop the loss.
Never sit on your holdings like a stock investor does to wait for a rebound. The price of a warrant will be dragged down by not only a falling underlying price, but also a declining time value.
Additional notes:
Warrants are derivatives.
They are an alternative investment to their underlying, and vice versa.
Warrants can never be an absolute substitute for their underlying.
Do manage your portfolio flexibly by investing in warrants and/or their underlying in light of the market conditions and outlook, as well as your own risk tolerance.
If one gets the market wrong, one will lose more from warrants (actual loss over investment cost) than from stocks.
That means the leverage effect of warrants is a double-edged sword. (Investors must take caution.)
The investment cost for warrants is lower than that for stocks, but they are more volatile.
Hence, their rate of potential gain or loss is much higher than their underlying.
Summary:
Warrants are a leveraged investment tool.
Don't foreget that the leverage effect can mean more profit, but also more loss.
So do limit your investment amount in warrants.
However, some investors may choose to buy a related warrant instead.
Pros: Limited investment amount.
The biggest advantage of warrants is the leverage effect, which allows you to invest with less capital for the same return, as compared with stock trading.
The lower capital required for warrants means that, in case there is a market downturn, the loss will be limited as compared with investing directly in the stock.
In fact, in a number of major setbacks in the past, even giant blue chips fell sharply. Buying warrants instead of stocks can help minimize one's exposure to such market risks.
Cons: Time constraint
Of course, warrants are not without their shortcomings.
It takes a lot of time to understand the factors that may affect warrant prices before one can master the leverage effect to one's advantage.
Investors must get to know that warrants are subject to the time constraint.
The price of a warrant may change along with the implied volatility and dividend payout of its underlying and interest rates.
Even if you get the underlying direction right, you may still fail to reap the expected return.
In case you get it wrong, you should stop the loss.
Never sit on your holdings like a stock investor does to wait for a rebound. The price of a warrant will be dragged down by not only a falling underlying price, but also a declining time value.
Additional notes:
Warrants are derivatives.
They are an alternative investment to their underlying, and vice versa.
Warrants can never be an absolute substitute for their underlying.
Do manage your portfolio flexibly by investing in warrants and/or their underlying in light of the market conditions and outlook, as well as your own risk tolerance.
If one gets the market wrong, one will lose more from warrants (actual loss over investment cost) than from stocks.
That means the leverage effect of warrants is a double-edged sword. (Investors must take caution.)
The investment cost for warrants is lower than that for stocks, but they are more volatile.
Hence, their rate of potential gain or loss is much higher than their underlying.
Summary:
Warrants are a leveraged investment tool.
Don't foreget that the leverage effect can mean more profit, but also more loss.
So do limit your investment amount in warrants.
Index Futures
In terms of trading, index futures are more straightforward.
When the index rises by a certain percentage, an index future buyer will gain while an index future seller will lose, exactly the same amount.
Trading in index futures is a zero sum game, and buyers and sellers gamble against each other.
Regarding capital requirement, a margin is payable upfront for an index future contract.
The investor has to pay the shortfall (margin call) to maintain the account balance at not less than the maintenance margin level.
An example: The initial margin required for a particular Index futures contract is $688 and the maintenance margin required is $550. Each point of the index is priced at $16. The investor will face a margin call if the particular index drops by more than 13 points, as the investor has to pay the shortfall to maintain the account balance at not less than the maintenance margin level.
When the index rises by a certain percentage, an index future buyer will gain while an index future seller will lose, exactly the same amount.
Trading in index futures is a zero sum game, and buyers and sellers gamble against each other.
Regarding capital requirement, a margin is payable upfront for an index future contract.
The investor has to pay the shortfall (margin call) to maintain the account balance at not less than the maintenance margin level.
An example: The initial margin required for a particular Index futures contract is $688 and the maintenance margin required is $550. Each point of the index is priced at $16. The investor will face a margin call if the particular index drops by more than 13 points, as the investor has to pay the shortfall to maintain the account balance at not less than the maintenance margin level.
Wednesday 9 September 2015
Options - Trading mechanism
If you are optimistic about the underlying, you can buy a call option or write a put option.
If you are negative about the underlying, you can choose to buy a put option or write a call option.
If you are positive about the underlying
If an investor wants to buy a call option, he needs to pay a premium upfront. In case the underlying price does rise above the strike price, the investor can exercise the option to earn the difference.
If the investor chooses to write a put option, he will receive a premium. If the underlying price climbs above the strike price, the put option will become worthless (and not exercised), leaving the premium safe in the hands of the investor. In writing a put option, the investor is required to deposit a margin and face the risk of unlimited loss (in theory), the underlying price can drop to zero).
If you are negative about the underlying
If the investor chooses to buy a put option, he needs to pay a premium upfront. In case the underlying price does fall below the strike price, the investor can exercise the option to earn the difference.
If the investor chooses to write a call option, and if the underlying price falls below the strike price, he will pocket the full amount of the premium. On the other hand, if the underlying price is higher than the strike price, he will face the risk of unlimited loss (in theory, the underlying price can go up indefinitely).
Warrants versus Options
In the case of warrants, the investor can only be a buyer, and choose between call warrants or put warrants. The seller is always the issuer.
While options offer more possibilities, the risk is also much bigger. In contrast, warrants are only subject to limited risk exposure.
If you are negative about the underlying, you can choose to buy a put option or write a call option.
If you are positive about the underlying
If an investor wants to buy a call option, he needs to pay a premium upfront. In case the underlying price does rise above the strike price, the investor can exercise the option to earn the difference.
If the investor chooses to write a put option, he will receive a premium. If the underlying price climbs above the strike price, the put option will become worthless (and not exercised), leaving the premium safe in the hands of the investor. In writing a put option, the investor is required to deposit a margin and face the risk of unlimited loss (in theory), the underlying price can drop to zero).
If you are negative about the underlying
If the investor chooses to buy a put option, he needs to pay a premium upfront. In case the underlying price does fall below the strike price, the investor can exercise the option to earn the difference.
If the investor chooses to write a call option, and if the underlying price falls below the strike price, he will pocket the full amount of the premium. On the other hand, if the underlying price is higher than the strike price, he will face the risk of unlimited loss (in theory, the underlying price can go up indefinitely).
Warrants versus Options
In the case of warrants, the investor can only be a buyer, and choose between call warrants or put warrants. The seller is always the issuer.
While options offer more possibilities, the risk is also much bigger. In contrast, warrants are only subject to limited risk exposure.
Five Major Factors influencing Warrant Price
1. Underlying price
2. Days to Maturity.
3. Implied Volatility
4. Interest Rate
5. Dividend.
2. Days to Maturity.
3. Implied Volatility
4. Interest Rate
5. Dividend.
How to trade warrants?
1. Select a bank or broker.
2. Open a securities account.
3. Monitor warrant trading through a stock quote terminal.
4. Study carefully the underlying stock and the terms of the warrant.
5. Trade warrant.
2. Open a securities account.
3. Monitor warrant trading through a stock quote terminal.
4. Study carefully the underlying stock and the terms of the warrant.
5. Trade warrant.
Monday 26 January 2015
Approach to Convertible Issues
An illustration on convertible issue
The fine balance between what is given and what is withheld in a standard-type convertible issue is well illustrated by the extensive use of this type of security in the financing of American Telephone & Telegraph Company.
Since 1913 the company has sold at least seven separate issues of convertible bonds, most of them through subscription rights to stockholders.
The convertible bonds had the important advantage to the company of bringing in a much wider class of buyers than would have been available for a stock offering, since the bonds are popular with many financial institutions which possess huge resources but some of which are not permitted to buy stocks.
The interest return on the bonds has generally been less than half the corresponding dividend yield on the stock - a factor which was calculated to offset the prior claim of the bondholders.
Since the company has been able to maintain its dividend without change for many years, the result has been the eventual conversion of all the older convertible issues into stock.
Thus the buyers of these convertibles have fared well through the years - but not quite so well as if they had bought the capital stock in the first place.
This example establishes the soundness of American Telephone & Telegraph, but not the intrinsic attractiveness of convertible bonds.
To prove them sound in practice we should need to have a number of instances in which the convertible worked out well even though the common stock proved disappointing.
Such instances are not easy to find.
$$$$$
Advice by Benjamin Graham on convertibles
Our general attitude toward new convertible issues is thus a mistrustful one.
We mean here, as in other similar observations, that the investor should look more than twice before he buys them.
After such hostile scrutiny he may find some exceptional offerings that are too good to refuse.
The ideal combination, of course, is a strongly secured convertible, exchangeable for a common stock which itself is attractive, and at a price only slightly higher than the current market.
Every now and then a new offering appears that meets these requirements.
By the nature of the securities markets, however, you are more likely to find such an opportunity in some older issue which has developed into a favorable position rather than in a new flotation.
(If a new issue is a really strong one, it is not likely to have a good conversion privilege.)
Benjamin Graham
The Intelligent Investor
The fine balance between what is given and what is withheld in a standard-type convertible issue is well illustrated by the extensive use of this type of security in the financing of American Telephone & Telegraph Company.
Since 1913 the company has sold at least seven separate issues of convertible bonds, most of them through subscription rights to stockholders.
The convertible bonds had the important advantage to the company of bringing in a much wider class of buyers than would have been available for a stock offering, since the bonds are popular with many financial institutions which possess huge resources but some of which are not permitted to buy stocks.
The interest return on the bonds has generally been less than half the corresponding dividend yield on the stock - a factor which was calculated to offset the prior claim of the bondholders.
Since the company has been able to maintain its dividend without change for many years, the result has been the eventual conversion of all the older convertible issues into stock.
Thus the buyers of these convertibles have fared well through the years - but not quite so well as if they had bought the capital stock in the first place.
This example establishes the soundness of American Telephone & Telegraph, but not the intrinsic attractiveness of convertible bonds.
To prove them sound in practice we should need to have a number of instances in which the convertible worked out well even though the common stock proved disappointing.
Such instances are not easy to find.
$$$$$
Advice by Benjamin Graham on convertibles
Our general attitude toward new convertible issues is thus a mistrustful one.
We mean here, as in other similar observations, that the investor should look more than twice before he buys them.
After such hostile scrutiny he may find some exceptional offerings that are too good to refuse.
The ideal combination, of course, is a strongly secured convertible, exchangeable for a common stock which itself is attractive, and at a price only slightly higher than the current market.
Every now and then a new offering appears that meets these requirements.
By the nature of the securities markets, however, you are more likely to find such an opportunity in some older issue which has developed into a favorable position rather than in a new flotation.
(If a new issue is a really strong one, it is not likely to have a good conversion privilege.)
Benjamin Graham
The Intelligent Investor
Friday 21 February 2014
Should you bother with options, rights, or warrants?
Options
Options are relatively complicated financial instruments. Most people lose money using options. The obvious question is whether you should even bother with using options.
Options do have characteristics that make them unattractive to some investors:
There are also a number of reasons for using options:
Options are relatively complicated financial instruments. Most people lose money using options. The obvious question is whether you should even bother with using options.
Options do have characteristics that make them unattractive to some investors:
- Options contracts have short lives, and investors could lose their entire investment if the stock price does not change in the predicted direction within the time frame.
- Investors could lose their entire investment even if the stock price moves in the predicted direction after the time frame.
- The risk of loss is not limited when selling uncovered calls or puts.
There are also a number of reasons for using options:
- Investors can profit from using options without having to invest larger amounts to buy the underlying equity. In other words, investing in options costs a fraction of the cost of buying the stock.
- Returns on invested funds from the use of options is much greater than investing in stocks.
- The risk of loss is limited to the cost of the premium paid on the option when buying options.
- Mini options were launched on March 18, 2013. They represent 10 shares of stock, as opposed to regular options contracts, which represent 100 shares, with the aim of creating a broader audience for this market.
Rights and Warrants
Understanding what rights and warrants are can assist investors in determining a course of action when faced with having to make decisions about them.
Related:
Related:
Options, rights and warrants
Thursday 20 February 2014
Options, rights and warrants
Options have many uses and investors need to be aware of their ramifications in order to be able to use them.
In order to do so, investors need to familiarize themselves with knowledge about options.
Learning the Vocabulary
Options: They are stock derivative investments.
Derivative security: A financial security that derives its value from another security.
Options and futures: These are stock derivatives that offer investors some of the benefits of stocks without having to own them.
Options contract: This gives the holder the right to buy or sell shares of a particular common stock at a predetermined price (strike price) on or before a specified date (expiration date).
Option: An option is a right, not an obligation, to buy or to sell stock at a specified price before or on an expiration date.
Strike price: The price at which the holder of the option can buy or sell the stock.
Expiration date: An option expires on its expiration date.
Stock Option: This is a derivative security because its value depends on the underlying security, which is the common stock of the company.
Options market: Chicago Board Options Exchange (CBOE), New York Stock Exchange (NYSE), the American Options Exchange (AOE), the Philadelphia Exchange (PHO), and the Pacific Exchange (PSE). Options can also be traded in the over-the-counter market.
Options websites: www.cboe.com, www.nyse.com/futuresoptions/nyseamex, www.amex.com, www.phlx.com. Click on all exchanges and list all options and LEAPS. Click on Submit, and a list of options for the stock you requested will appear.
Options contracts: Calls and Puts
Call option: A call option gives the option owner the right to buy shares of the underlying company at a predetermined price (strike price) before expiration.
Put option: A put option contract gives the option owner the right to sell shares of the underlying company at the strike price before expiration.
Option holder: Option holder has the right to convert the contract at his/her discretion. It is not an obligation. Holders of the option can exercise the option when it is to their advantage and let the options contract expire if it is not advantageous.
Options contract: SIX items of note in an options contract. 1. Name of the company whose shares can be bought or sold. 2. The number of shares that can be bought or sold, generally 100 shares per contract. 3. The exercise or strike price, which is the stated purchase or sale price of the shares in the contract. 4. The expiration date, which is the date when the option to buy or sell expires. 5. The settlement procedure. 6. The options exercise style.
Option buyer: The option buyer is also referred to as the option holder.
Option seller: The seller of the original contract is referred to as the option writer. In any contract, there are at least two parties: buyers and sellers.
Settlement procedure: This is stipulated for stock options, which indicates when delivery of the underlying common stock takes place after the holder exercises the option.
Options exercise style: There are two basic exercise styles that determine when the option can be exercised, namely, American style and European style.
American style: Options on individual stocks can be exercised ANY time before the expiration date.
European style: Stock index options can be exercised ONLY on expiration date.
Life of the option: The expiration date is also important, as it specifies the life of the option.
Standardized expiration dates: The expiration dates are standardized for options contracts listed on the exchanges. There are three cycles for listed option expirations, and each option is assigned to one of these cycles: January cycle: January-April-July-October; February:cycle: February-May-August-November; and March cycle: March-June-September-December.
Options Clearing Corporation (OCC): The trading of options is greatly facilitated by the Options Clearing Corporation, which, besides maintaining a liquid marketplace, also keeps track of the options and the positions of each investor. Buyers and writers of options do not deal directly with one another but instead with the OCC.
Contract period for stock options: The contract period for stock options is standardized with three-, six-, and nine-month expiration dates. Generally, two options on a stock are introduced to the market at the same time with identical terms except for the strike (exercise) price.
LEAPS (long-term equity anticipation securities): Longer-term options contracts, called LEAPS have life spans of up to three years before expiry. They have similar characteristics to the short-term options contracts but, because of their longer expiration periods, have higher premium prices.
Time value of an option: An option is a wasting asset. There is a time value to the price of an option. The more time before the option expires, the greater is the time value of the option. As the option moves closer to its expiration, so the time value of the option decreases in value. Generally, options are not normally exercised until they are close to expiry because an earlier exercise means throwing away the remaining time value. Another generalization with options (both calls and puts) is that most options are not bought with the intention of exercising them. Instead, they are bought with the intention of selling them.
Intrinsic value of the call option: The intrinsic value of a call option is the difference between the market price of the stock and the strike price. Intrinsic Value of Call Option = Market Price of the Stock - Strike Price.
In the money call option: When the market price is greater than the strike price, the call option is said to be in the money.
Out of the money call option: A call option is said to be out of the money when the market price of the stock is less than the strike price.
At the money call option: The market price of the option equals the strike price.
Time value of put option: Puts are wasting assets and have no value at expiration.
Intrinsic value of put option: The intrinsic value of the put option is determined by subtracting the market price of the stock from the strike price. Intrinsic Value of a Put Option = Strike Price - Market Price of the Stock.
Out of the money put option: If the put option has no intrinsic value, it is out of the money.
In the money put option: If the put option has intrinsic value, it is in the money; and it is profitable to exercise the put option.
At the money put option: If the strike price equals the market price of the stock, the option is at the money.
Writing options: Investors can also write or sell options, which provide additional income from the premiums received from the buyers of the option contracts. The upside potential to this strategy for option writers is limited, however, because the most money the writer can make is the amount of the option premium.
Writing covered option: A covered option is an option that is written against an underlying stock that is owned, or sold short, by the writer. The writer of the option owns the stock against which the options are written.
Writing naked option: This is the second method of writing an option. A naked option, is an option written on an underlying stock that is not owned or sold short by the writer.
Writing covered calls: A covered call limits the appreciation the writer can realize. Therefore, it is a good idea to write covered calls on the stocks you think won't rise or fall very much in price.
Writing naked call: Writing a naked call on a stock is more risky than writing a covered call because of the potential for unlimited losses. A naked call is when the writer does not own the underlying stock, which would limit the losses if the stock rocketed up in the price. Investors can profit from writing naked calls on stocks whose prices either decline or remain relatively flat below the strike price for calls.
Writing covered puts: The writer of a covered put sells short the underlying stock and receives a premium for the covered put. If the option is exercised, the writer would buy back the stock at the strike price and use the shares to close out his short position.
Writing naked puts: The writer of a put option expects the stock to rise or at best not fall in price. If the put writer does not own the underlying stock, the contract is a naked or uncovered put, which necessitates that the writer deposits an amount of money with the brokerage firm for the required margin.Without owning the underlying stocks, the potential loss is not cushioned if the price of the stock falls rapidly.
Combination of Puts and Calls: Straddle and Spread
Straddle: A straddle is the purchase (or sale) of a put and a call with the same strike price and the same expiration date.
Spread: A spread is the purchase or sale of a combination of put and call options contracts with different strike prices.
Stock Index Options: Stock index options allow investors to take long and short positions on the market without having to buy or sell short the stocks that make up the index. A stock index option is a put or call written on a market index. With stock index options you can track the markets without having to buy or sell the stocks. Options on stock indices are valued and trade in the same way as options on individual stocks with the notable exceptions that settlement is made in cash for the former.
Rights: A right, also known as a preemptive right, is an option allowing a shareholder to by additional shares of new stock of the company at a specified price within a specified time period before the shares are offered to the public. A right allows a current shareholder to buy more common stock of the company in advance of the public at a discounted price (subscription price). Stock rights are issued to existing shareholders on a stated date. These rights give existing shareholders the opportunity to maintain their same proportionate ownership in the company after the new issue of common stock. Rights, like options, can be bought for one of two reasons: either to exercise the rights or to speculate on the rights.
Trading cum rights: To be eligible to buy these additional shares at the subscription price, the common stock of the company must be owned as of the record date set by the board of directors. Most rights offering have a short period of time (between two and six weeks) for existing shareholders to either subscribe to the new shares or sell the rights. It is during this period that the stock is said to be trading cum rights, where the value of the right is included in the market price of the stock.
Trading ex-rights date: After a specified date, known as the ex-rights date, stock transactions do not include the rights. Theoretically, the stock price goes down after this date, when the rights trade separately.
Value of a right: The value of a right depends on the market price of the stock, the subscription price of the right, and the number of rights necessary to buy each new share.
Cum Rights Value: The formula to determine the value of the rights before they trade independently of the stock is as follows: Cum Rights Value = (Market Price of Stock - Subscription Price) / (Number of Rights to Buy a Share + 1)
Ex-rights Value: After the stock trades ex-rights, its price declines by the value of the right, because rights trade separately from the stock. Investors who want to buy the rights can purchase them on the market in the same way they can purchase the stock. The ex-rights value is calculated as follows; Ex-rights Value = (Market Price of Stock - Subscription Price) / (Number of Rights Needed to Buy a Share)
Warrants: A warrant is a security that allows its owner to purchase a stated number of shares of common stock at a specified price within a specified time period. A warrant is similar to a long-term option in that it gives the owner the right to by a stated number of shares of the underlying company's stock at a specific price within a specific period of time. The differences between warrants and options are that with warrants the specified price can be fixed or it can rise at certain intervals, such as every five years, and the company can extend the expiration date. Warrants have longer lives than options. An option can have a life of nine months or less; warrants extend for years, and some companies have issued perpetual warrants. Generally, there is a waiting period before warrants can be exercised. Corporations issue warrants as sweeteners with other securities issued by the company. Warrants can be attached to bonds or preferred stocks. In some cases, warrants have been distributed to shareholders in place of stock or cash dividends. The major advantage of warrants over options is that warrants have longer lives. Warrants do well when stock prices are rising, but investors should still be selective about the warrants they buy. If the stock never goes up in price, there is little to no opportunity to profit from buying the warrants. Generally, as with options, warrants should be bought to trade and not to exercise.
Value of a warrant: When a company issues warrants, the purchase price of the stock is generally fixed at a higher price than the market price of the stock at issue. Value of a warrant = (Market price of stock - Exercise price ) x (Number of shares purchased with the warrant).
Premium of a warrant: Premium = Market price of the warrant - Value of the warrant. If the market price of the stock never rises to the strike price of the warrant during its life, the warrant is not exercised and expires.
Related:
http://www.investlah.com/forum/index.php/topic,42222.0.html
In order to do so, investors need to familiarize themselves with knowledge about options.
Learning the Vocabulary
Options: They are stock derivative investments.
Derivative security: A financial security that derives its value from another security.
Options and futures: These are stock derivatives that offer investors some of the benefits of stocks without having to own them.
Options contract: This gives the holder the right to buy or sell shares of a particular common stock at a predetermined price (strike price) on or before a specified date (expiration date).
Option: An option is a right, not an obligation, to buy or to sell stock at a specified price before or on an expiration date.
Strike price: The price at which the holder of the option can buy or sell the stock.
Expiration date: An option expires on its expiration date.
Stock Option: This is a derivative security because its value depends on the underlying security, which is the common stock of the company.
Options market: Chicago Board Options Exchange (CBOE), New York Stock Exchange (NYSE), the American Options Exchange (AOE), the Philadelphia Exchange (PHO), and the Pacific Exchange (PSE). Options can also be traded in the over-the-counter market.
Options websites: www.cboe.com, www.nyse.com/futuresoptions/nyseamex, www.amex.com, www.phlx.com. Click on all exchanges and list all options and LEAPS. Click on Submit, and a list of options for the stock you requested will appear.
Options contracts: Calls and Puts
Call option: A call option gives the option owner the right to buy shares of the underlying company at a predetermined price (strike price) before expiration.
Put option: A put option contract gives the option owner the right to sell shares of the underlying company at the strike price before expiration.
Option holder: Option holder has the right to convert the contract at his/her discretion. It is not an obligation. Holders of the option can exercise the option when it is to their advantage and let the options contract expire if it is not advantageous.
Options contract: SIX items of note in an options contract. 1. Name of the company whose shares can be bought or sold. 2. The number of shares that can be bought or sold, generally 100 shares per contract. 3. The exercise or strike price, which is the stated purchase or sale price of the shares in the contract. 4. The expiration date, which is the date when the option to buy or sell expires. 5. The settlement procedure. 6. The options exercise style.
Option buyer: The option buyer is also referred to as the option holder.
Option seller: The seller of the original contract is referred to as the option writer. In any contract, there are at least two parties: buyers and sellers.
Settlement procedure: This is stipulated for stock options, which indicates when delivery of the underlying common stock takes place after the holder exercises the option.
Options exercise style: There are two basic exercise styles that determine when the option can be exercised, namely, American style and European style.
American style: Options on individual stocks can be exercised ANY time before the expiration date.
European style: Stock index options can be exercised ONLY on expiration date.
Life of the option: The expiration date is also important, as it specifies the life of the option.
Standardized expiration dates: The expiration dates are standardized for options contracts listed on the exchanges. There are three cycles for listed option expirations, and each option is assigned to one of these cycles: January cycle: January-April-July-October; February:cycle: February-May-August-November; and March cycle: March-June-September-December.
Options Clearing Corporation (OCC): The trading of options is greatly facilitated by the Options Clearing Corporation, which, besides maintaining a liquid marketplace, also keeps track of the options and the positions of each investor. Buyers and writers of options do not deal directly with one another but instead with the OCC.
Contract period for stock options: The contract period for stock options is standardized with three-, six-, and nine-month expiration dates. Generally, two options on a stock are introduced to the market at the same time with identical terms except for the strike (exercise) price.
LEAPS (long-term equity anticipation securities): Longer-term options contracts, called LEAPS have life spans of up to three years before expiry. They have similar characteristics to the short-term options contracts but, because of their longer expiration periods, have higher premium prices.
Time value of an option: An option is a wasting asset. There is a time value to the price of an option. The more time before the option expires, the greater is the time value of the option. As the option moves closer to its expiration, so the time value of the option decreases in value. Generally, options are not normally exercised until they are close to expiry because an earlier exercise means throwing away the remaining time value. Another generalization with options (both calls and puts) is that most options are not bought with the intention of exercising them. Instead, they are bought with the intention of selling them.
Intrinsic value of the call option: The intrinsic value of a call option is the difference between the market price of the stock and the strike price. Intrinsic Value of Call Option = Market Price of the Stock - Strike Price.
In the money call option: When the market price is greater than the strike price, the call option is said to be in the money.
Out of the money call option: A call option is said to be out of the money when the market price of the stock is less than the strike price.
At the money call option: The market price of the option equals the strike price.
Time value of put option: Puts are wasting assets and have no value at expiration.
Intrinsic value of put option: The intrinsic value of the put option is determined by subtracting the market price of the stock from the strike price. Intrinsic Value of a Put Option = Strike Price - Market Price of the Stock.
Out of the money put option: If the put option has no intrinsic value, it is out of the money.
In the money put option: If the put option has intrinsic value, it is in the money; and it is profitable to exercise the put option.
At the money put option: If the strike price equals the market price of the stock, the option is at the money.
Writing options: Investors can also write or sell options, which provide additional income from the premiums received from the buyers of the option contracts. The upside potential to this strategy for option writers is limited, however, because the most money the writer can make is the amount of the option premium.
Writing covered option: A covered option is an option that is written against an underlying stock that is owned, or sold short, by the writer. The writer of the option owns the stock against which the options are written.
Writing naked option: This is the second method of writing an option. A naked option, is an option written on an underlying stock that is not owned or sold short by the writer.
Writing covered calls: A covered call limits the appreciation the writer can realize. Therefore, it is a good idea to write covered calls on the stocks you think won't rise or fall very much in price.
Writing naked call: Writing a naked call on a stock is more risky than writing a covered call because of the potential for unlimited losses. A naked call is when the writer does not own the underlying stock, which would limit the losses if the stock rocketed up in the price. Investors can profit from writing naked calls on stocks whose prices either decline or remain relatively flat below the strike price for calls.
Writing covered puts: The writer of a covered put sells short the underlying stock and receives a premium for the covered put. If the option is exercised, the writer would buy back the stock at the strike price and use the shares to close out his short position.
Writing naked puts: The writer of a put option expects the stock to rise or at best not fall in price. If the put writer does not own the underlying stock, the contract is a naked or uncovered put, which necessitates that the writer deposits an amount of money with the brokerage firm for the required margin.Without owning the underlying stocks, the potential loss is not cushioned if the price of the stock falls rapidly.
Combination of Puts and Calls: Straddle and Spread
Straddle: A straddle is the purchase (or sale) of a put and a call with the same strike price and the same expiration date.
Spread: A spread is the purchase or sale of a combination of put and call options contracts with different strike prices.
Stock Index Options: Stock index options allow investors to take long and short positions on the market without having to buy or sell short the stocks that make up the index. A stock index option is a put or call written on a market index. With stock index options you can track the markets without having to buy or sell the stocks. Options on stock indices are valued and trade in the same way as options on individual stocks with the notable exceptions that settlement is made in cash for the former.
Rights: A right, also known as a preemptive right, is an option allowing a shareholder to by additional shares of new stock of the company at a specified price within a specified time period before the shares are offered to the public. A right allows a current shareholder to buy more common stock of the company in advance of the public at a discounted price (subscription price). Stock rights are issued to existing shareholders on a stated date. These rights give existing shareholders the opportunity to maintain their same proportionate ownership in the company after the new issue of common stock. Rights, like options, can be bought for one of two reasons: either to exercise the rights or to speculate on the rights.
Trading cum rights: To be eligible to buy these additional shares at the subscription price, the common stock of the company must be owned as of the record date set by the board of directors. Most rights offering have a short period of time (between two and six weeks) for existing shareholders to either subscribe to the new shares or sell the rights. It is during this period that the stock is said to be trading cum rights, where the value of the right is included in the market price of the stock.
Trading ex-rights date: After a specified date, known as the ex-rights date, stock transactions do not include the rights. Theoretically, the stock price goes down after this date, when the rights trade separately.
Value of a right: The value of a right depends on the market price of the stock, the subscription price of the right, and the number of rights necessary to buy each new share.
Cum Rights Value: The formula to determine the value of the rights before they trade independently of the stock is as follows: Cum Rights Value = (Market Price of Stock - Subscription Price) / (Number of Rights to Buy a Share + 1)
Ex-rights Value: After the stock trades ex-rights, its price declines by the value of the right, because rights trade separately from the stock. Investors who want to buy the rights can purchase them on the market in the same way they can purchase the stock. The ex-rights value is calculated as follows; Ex-rights Value = (Market Price of Stock - Subscription Price) / (Number of Rights Needed to Buy a Share)
Warrants: A warrant is a security that allows its owner to purchase a stated number of shares of common stock at a specified price within a specified time period. A warrant is similar to a long-term option in that it gives the owner the right to by a stated number of shares of the underlying company's stock at a specific price within a specific period of time. The differences between warrants and options are that with warrants the specified price can be fixed or it can rise at certain intervals, such as every five years, and the company can extend the expiration date. Warrants have longer lives than options. An option can have a life of nine months or less; warrants extend for years, and some companies have issued perpetual warrants. Generally, there is a waiting period before warrants can be exercised. Corporations issue warrants as sweeteners with other securities issued by the company. Warrants can be attached to bonds or preferred stocks. In some cases, warrants have been distributed to shareholders in place of stock or cash dividends. The major advantage of warrants over options is that warrants have longer lives. Warrants do well when stock prices are rising, but investors should still be selective about the warrants they buy. If the stock never goes up in price, there is little to no opportunity to profit from buying the warrants. Generally, as with options, warrants should be bought to trade and not to exercise.
Value of a warrant: When a company issues warrants, the purchase price of the stock is generally fixed at a higher price than the market price of the stock at issue. Value of a warrant = (Market price of stock - Exercise price ) x (Number of shares purchased with the warrant).
Premium of a warrant: Premium = Market price of the warrant - Value of the warrant. If the market price of the stock never rises to the strike price of the warrant during its life, the warrant is not exercised and expires.
Related:
http://www.investlah.com/forum/index.php/topic,42222.0.html
Sunday 9 December 2012
Let's look at reasons to invest in warrants and how to go about it.
Why invest in warrants?
Gearing effect
A hedging tool
As with any instrument, money can be made and lost when trading warrants.
Mr. X, 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.
Investors should also be disciplined about taking profits and cutting losses. Investors are advised to monitor their positions closely as warrants tend to move in greater percentage terms than shares.
Mr. P, 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.
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.
'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.'
'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.'
What are the five variables and how do they affect an option's value or premium?
Options values or premiums on puts and calls are function of five variables. The five variables are:
1. the underlying asset value,
2. the risk-free rate,
3. the standard deviation of the return of the asset,
4. the option's time to maturity, and
5. the option's exercise price.
A call option's value will increase with increases in the underlying asset value, risk-free rate, time to maturity, and standard deviation of returns. However, a call's premium will decrease as the striking price increases.
A put's value will increase with increases in the exercise price, the time to maturity and standard deviation of returns, and decrease with increases in the underlying asset value and risk-free rate.
If dividends are considered, a call's value will decrease with dividends while a put's value will increase.
Friday 7 December 2012
Warrants trading: What you need to know
| Cheap investment tools were virtually non-existent in Singapore a few years ago, but a recent growth spurt has sent their popularity soaring. Gabriel Chen Sun, Dec 02, 2007 The Sunday Times 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 investingFIRST, 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%2BMoney/Building%2BYour%2BNest%2BEgg/Investments%2BAnd%2BSavings/Story/A1Story20071205-39670.html
http://forum.lowyat.net/topic/1039913/all (Good notes on warrants)
Warrants Basics
A
Break-even point
That implies the price level at which the investor will break-even on warrant expiry; for instant, the investor will make profit if the closing price is higher than strike price.
Broad Lot
The minimum number of warrants that can be traded on the Singapore Stock Exchange.
C
That implies the price level at which the investor will break-even on warrant expiry; for instant, the investor will make profit if the closing price is higher than strike price.
Broad Lot
The minimum number of warrants that can be traded on the Singapore Stock Exchange.
C
Call
A call warrant provides the holder with a right, but not an obligation, to buy a stock/index at a pre-determined strike price on maturity date. However, currently most of the warrants are cash settled.
Conversion ratio
It indicates the number of warrants related to one share of the underlying that the holder is entitled to buy or sell.
D
A call warrant provides the holder with a right, but not an obligation, to buy a stock/index at a pre-determined strike price on maturity date. However, currently most of the warrants are cash settled.
Conversion ratio
It indicates the number of warrants related to one share of the underlying that the holder is entitled to buy or sell.
D
Delta
Delta measures "how much the warrant price will move for a one dollar move in the underlying security". The delta of a call warrant has an upper bound of 1.00 (decimal format) or 100% (percent format) and a lower bound of zero. A call warrant with a delta of 1.00 will move up or down one full point for each full point move up or down in the price of the underlying security. A call warrant with a delta of zero should move negligibly, even if the underlying security makes a relatively large move. Warrants that are at-the-money have a delta of approximately 0.50.
For put warrants, the delta lies between -1.00 (or -100%) and zero. A rise in the underlying security will bring about a drop in the price of a put warrant.
E
Delta measures "how much the warrant price will move for a one dollar move in the underlying security". The delta of a call warrant has an upper bound of 1.00 (decimal format) or 100% (percent format) and a lower bound of zero. A call warrant with a delta of 1.00 will move up or down one full point for each full point move up or down in the price of the underlying security. A call warrant with a delta of zero should move negligibly, even if the underlying security makes a relatively large move. Warrants that are at-the-money have a delta of approximately 0.50.
For put warrants, the delta lies between -1.00 (or -100%) and zero. A rise in the underlying security will bring about a drop in the price of a put warrant.
E
Effective Gearing
A warrant's effective gearing is the relative percent change in a warrant's value for a given percent change in the price of the underlying security. A warrant's effective gearing is not constant and is higher for warrants which are out-of-the-money and/or close to expiry.
Expressed mathematically:
A warrant's effective gearing is the relative percent change in a warrant's value for a given percent change in the price of the underlying security. A warrant's effective gearing is not constant and is higher for warrants which are out-of-the-money and/or close to expiry.
Expressed mathematically:
Effective gearing = gearing x delta
Gamma*
It is the rate of change of the portfolio's delta with respect to the price of the underlying asset.
Gearing
The ratio of the share price to the warrant price (multiplied by the conversion ratio, if applicable).
It is the rate of change of the portfolio's delta with respect to the price of the underlying asset.
Gearing
The ratio of the share price to the warrant price (multiplied by the conversion ratio, if applicable).
| Gearing = | ___________share price__________ |
| warrant price x conversion ratio |
Hedging
A trade designed to reduce risk, for instance, a put warrant may act as hedge for a current holding in the underlying asset.
I
A trade designed to reduce risk, for instance, a put warrant may act as hedge for a current holding in the underlying asset.
I
Implied Volatility
Implied volatility is the volatility anticipated by the financial markets. The higher the implied volatility, the higher the value of the warrant.
Implied volatility is also the volatility implicit in the market price of the warrant. For warrants of similar terms, the higher the implied volatility, the more expensive a warrant is.
In-the-money (ITM)
A warrant with the strike below (for a call warrant) or above (for a put warrant) the price of the underlying security.
Intrinsic Value
For a call warrant, the amount that equals to the market value of the underlying security less the strike. For a put warrant, the amount that equals to the strike less the market value of the underlying security. The intrinsic value corresponds to the amount by which a warrant is in-the-money.
L
Implied volatility is the volatility anticipated by the financial markets. The higher the implied volatility, the higher the value of the warrant.
Implied volatility is also the volatility implicit in the market price of the warrant. For warrants of similar terms, the higher the implied volatility, the more expensive a warrant is.
In-the-money (ITM)
A warrant with the strike below (for a call warrant) or above (for a put warrant) the price of the underlying security.
Intrinsic Value
For a call warrant, the amount that equals to the market value of the underlying security less the strike. For a put warrant, the amount that equals to the strike less the market value of the underlying security. The intrinsic value corresponds to the amount by which a warrant is in-the-money.
L
Last trading Day
The last trading day of a structured warrant is the fifth trading day prior to the maturity date. After the last trading day, investors will not be able to buy or sell the structured warrant in the market.
M
The last trading day of a structured warrant is the fifth trading day prior to the maturity date. After the last trading day, investors will not be able to buy or sell the structured warrant in the market.
M
Out-of-the-money (OTM)
A warrant with the strike above (for a call warrant) or below (for a put warrant) the price of the underlying security.
P
A warrant with the strike above (for a call warrant) or below (for a put warrant) the price of the underlying security.
P
Premium
The percentage by which the underlying share price needs to have moved at maturity for the investor to break even.
The percentage by which the underlying share price needs to have moved at maturity for the investor to break even.
Premium for a call warrant (%)
Premium for a put warrant (%)
|
Put
A put warrant provides the holder with a right, but not an obligation, to sell a stock/index at a pre-determined strike price on maturity date. However, currently most of the warrants are cash settled.
S
A put warrant provides the holder with a right, but not an obligation, to sell a stock/index at a pre-determined strike price on maturity date. However, currently most of the warrants are cash settled.
S
Strike Price
It is the price at which the warrant-holder to buy (a call) or to sell (a put) the underlying asset. However, currently most of the warrants are cash settled.
T
It is the price at which the warrant-holder to buy (a call) or to sell (a put) the underlying asset. However, currently most of the warrants are cash settled.
T
Theta*
It is the rate of change of the value of the portfolio with respect to the passage of time with all else remaining the same. Theta is sometimes referred to as the time decay of the portfolio.
Time Value
The portion of a warrant's price that is not accounted for by the intrinsic value.
U
It is the rate of change of the value of the portfolio with respect to the passage of time with all else remaining the same. Theta is sometimes referred to as the time decay of the portfolio.
Time Value
The portion of a warrant's price that is not accounted for by the intrinsic value.
U
Vega*It is the rate of change of the value of the portfolio with respect to the volatility of the underlying asset.
Volatility*
A measure of the uncertainty of the return realized on an asset.
Volatility*
A measure of the uncertainty of the return realized on an asset.
*Source: Options, Futures, and other derivatives (Fifth edition), John C. Hull
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.
Thursday 1 November 2012
AmBank issues new structured warrants
Friday October 26, 2012
KUALA LUMPUR: AmBank (M) Bhd is issuing five new European style cash-settled structured call warrants (CW) over the ordinary shares ofAstro Malaysia Holdings Bhd, Lingkaran Trans Kota Holdings Bhd andTop Glove Corp Bhd.
It is also issuing one European style cash-settled structured put warrant (PW) over the ordinary shares of Astro to meet investors’ demand for trading and investment opportunities in the current market scenario,AmBank Group said in a statement.
The structured warrants will be listed for trading on Oct 29, via the market making method, with issue size of up to 100 million each.
Director/head, equity derivatives, AmInvestment Bank Ng Ee Fang said:“As Malaysia’s benchmark FBMKLCI Index inched higher to hit new record highs, investor optimism remains as the local stock market is buoyed by liquidity and strong demand for good quality, high-yielding equity names.
“The slew of high-profile, multi-billion dollar IPOs year-to-date also played a significant part in attracting global investors’ interest to the local bourse.”
Besides Felda Global Ventures and IHH Healthcare, Ng said Astro became the third multi-billion dollar IPO on Bursa Malaysia this year when it raised US$1.5bil from its IPO last Friday.
“Therefore, for AmBank’s upcoming tranche of warrants, AmBank will be offering three call warrants and one put warrant over Astro to provide investors opportunities to participate and trade on both the direction and volatility of Astro.
There will also be two call warrants over Top Glove and Litrak.
AmBank’s three CWs on Astro are priced at 15 sen each with gearings of 2.5 and 4 times.
AmBank’s PW on Astro is also priced at 15 sen each with gearing of 5 times.
AmBank’s CW on Top Glove is priced at 15 sen each with gearing of 2.96 times while the CW on Litrak is priced at 15 sen each with gearing of 2.7 times.
This offer is aimed at sophisticated traders who want to trade on the direction and volatility of Astro, Top Glove and Litrak. – Bernama
Wednesday 14 March 2012
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.
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
Sunday 11 March 2012
Warrants trading: What you need to know
Parameters & Variables of Structured Warrants
To figure out the relationship between share price and the associated warrant price, the investor has to break down the premium factor that he/she pays for. Premium, Intrinsic & Time Values: The premium measures the extra cost incurred when buying a warrant and “exercising” the warrant into share over direct share purchase.
Premium = [(Warrant Price + Exercise Price) - Share Price) / Share Price] x 100%
Example (Diagram 1): if a warrant priced at RM0.50, has an exercise price of RM1.00, while the underlying share price is RM1.20, the premium on the warrant is 25%.
Premium (%) = [(0.50+1.00)-1.20]/1.20 x 100% = 25%
Warrant Price = Intrinsic Value + Time Value
The intrinsic value of a warrant is the difference between share and exercise price. In our example, the warrant’s intrinsic value of RM0.20 represents the possibility of buying shares for RM1.00, even though the market share price is RM1.20 (Diagram 2).
The additional RM0.30 is known as the time value. It reflects the payment for profit opportunity if the underlying share moves in the warrant buyer’s favour. In our example, if the warrant was to expire tomorrow, it would be priced around RM0.20. But if the warrant has 9 months before expiry, there's a high chance of the share price increasing. At a time value of RM0.30, this tells us that investors are willing to pay RM0.30 for the potential future gains before warrant expiry. The downside is that time value will fall closer to zero as the expiry date approaches. This is known as time decay.
If a warrant is out-of-the-money, by definition the warrant has no intrinsic value. In this case, the time value component accounts wholly for warrant price.
The price will not be lower than its intrinsic value due to the possibility of a risk-less arbitrage – where one buys the warrants and exercises them into shares, for a lower market share price. If a warrant is deep in-the-money, or expires shortly, the price may trade at a small discount to its intrinsic value.
Valuing Premium & Time Value: A warrant with a time value of RM0.20 is not necessarily “cheaper” than one at RM0.30. Both premium and time value parameters must be used in comparisons.
Deep out-of-the-money warrants have high premiums, which get lower when becoming more in-the-money. Premiums are regarded as measures of warrant price. While intrinsic value is directly related to share and fixed exercise price, the unpredictable nature of time value makes analysis difficult.
Implied Volatility: In determining “fair value” of warrants, the most adopted pricing model is the Black-Scholes one. It takes into account the inter-relationship between share and exercise price, expiry date, risk-free interest rate and volatility.
Volatility represents absolute price movements, of the underlying share over a time period. Traders need to understand that huge volatility is actually beneficial due to “limited loss, unlimited upside” characteristics of structured warrants.
There are two volatility types – historical, which calculates past variations of underlying share price, and implied, which represents market expectations of future volatility in underlying share price.
Examining historical volatility requires care, since short-term can differ from longer term. Besides underlying share direction, investors need to question if current volatility is likely to continue.
Implied volatility is derived from working backwards the current warrant price through the Black-Scholes equation. A warrant is expensive if implied volatility outweighs historical volatility assuming full market efficiency. In reality, implied volatility takes into account maturity length, nature of warrants, and spot/strike levels. Implied volatility is generally higher for longer-dated warrants and put warrants and at-the-money warrants.
http://bursaedge.blogspot.com/2012/02/warrants-education-2.html
Wednesday 8 February 2012
The Risk of Investing in Warrants
A warrant is an investment tool which provides opportunity for investors to diversify their investment. It is popular among retail investors, mainly due to its low cost investment and potential high return characteristics. This makes it even accessible to small investors who are without much additional capital.
However, many investors are investing into warrant without fully understanding the fundamental mechanics of how warrant works and the risk inherent in it. At the end of this article, you will be able to understand the basics of warrants and its implications on your investment decisions.
Types of warrants
A warrant gives you, as the buyer, the right but not the obligation, to buy or sell a specific number of the mother share or underlying shares at a specified price within a specific period. The holder of a warrant or call warrant will not have any voting or dividend rights as that enjoyed by shareholders. One of the main benefits of investing in a warrant is cost leveraging. When you invest in a warrant, you stand to gain from the exposure of the share price movement at only a fraction of its cost.
There are two types of warrants: call warrant and put warrant.
A call warrant is one that is most common in our local stock exchange and is almost similar to an option. A warrant is issued by the company of its underlying stock, while an option is a financial instrument of the stock exchange. Warrants are usually issued by companies as part of new issue offering to attract investors into buying the new security. A warrant is also considered a type of equity derivative as it derives its value from its underlying security.
Exercise price (strike price)
The price at which you can buy call warrant is called the exercise price and this is determined at point of issue. The exercise price is the point of reference for you to determine whether your warrant is Out-of-the-Money (OTM), In-the-Money (ITM) or At-the-Money (ATM).
Gearing effect
One of the reasons why warrant attracts investors is mainly because it costs only a fraction of the price of the underlying stock while offering relatively good return, either positive or negative.
Let’s take an example of ABC shares that are currently priced on the market at RM2.00 per share. Investor A puts in RM2,000 to purchase 1,000 shares. Investor B on the other hand, decides to invest the same capital of RM2,000 in warrants that was going for RM0.50 per warrant. With the same amount of investment, Investor B is in possession of 4,000 shares.
If ABC gains RM0.30 per share from RM2.00, to close at RM2.30, the percentage gain would be 15%. However, with a RM0.30 gain in the warrant, from RM0.50 to RM0.80, the percentage gain would be 60%.
This is the leveraging effect of warrant. However, the possibility of huge gain also comes hand in hand with huge loss. During the life time of a warrant, it is also common that the price of warrant moves in parallel with the price of the underlying stock. Due to the leveraging effect, a small decline in the price of the underlying stock will result in a significant drop in the price of its warrant.
Using the example above, assuming the price of the underlying stock reduce from RM2.00 to RM1.80, the percentage drop is 10%, but, with the same amount of RM0.30 reduction in the warrant, it will cause the warrant to drop to RM0.20, which is a 60% drop in value.
Time to maturity
All warrants have a limited life span. In the event that the price of the underlying stock remains below the exercise price at the time the warrant matures, an OTM warrant will be of no value and the investor will lose his investment.
Risk control
Having such a high risk nature, investors who are interested in warrants must fully understand their own risk tolerance level. Too much exposure in warrant may subject their investment portfolio to excessive risk. Many investors tend to purchase warrants that are highly active in the market without much knowledge of what they are buying. As warrants are also popular among short-term speculators, an actively traded warrant may not be suitable for investors who intend to hold the warrant for a longer term. The amount could be provided by short-term traders who are speculating and attempting to earn short-term profit. Therefore, it is important for investors to pay attention to the type of market participants that are interested in the warrant.
Buying ITM warrants may offer less profit but lower risk compared to the OTM warrants. When a warrant is deeply OTM, it is less sensitive to the price movement of its underlying stock, which means even if the price of the stock increases, the price of its warrant may not have significant movement, as what we would expect out of a warrant that is near or in-the-money. Worst still, if the term of warrant is near to its maturity; its time value will decline drastically.
As in any other investment, investors should make sure that they fully understand the characteristics of warrant before they decide to invest in any of it.
© Securities Industry Development Corporation. For more information on wise investing, log on to Malaysian Investor (www.min.com.my)
http://www.min.com.my/en/component/content/article/320-risk-of-investing-in-warrants.html?start=1
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