Tutorials
Basics of Structured Warrants
Before you can begin trading in warrants, it is important to understand what a warrant is.
A warrant is a securitized option on an underlying asset, usually equities, a basket of equities or indices, that is listed on an exchange. It is a leveraged trading instrument that gives you exposure to an asset at a fraction of the cost, and the chance to enjoy geared returns when the market moves in your favour - the converse in this case would be true too.
Call Warrants
A call warrant gives the buyer the right but not the obligation to buy the underlying asset at a predetermined price, called the strike or exercise price, on or before a predetermined date called the expiry date.
An investor would buy a call warrant with a view that the prices of the underlying asset will rise during the lifetime of the warrant. This would translate into a rise in warrant price as well.
When a call warrant expires, if the current price of the underlying instrument is higher than the exercise price of the warrant, the call on the warrant will be automatically exercised and the holder of the warrant will receive cash.
The amount of cash received will be the difference between the current price of the underlying asset and the exercise price of the warrant after adjustment due to the conversion ratio.
For example:
Share price: $12.00
Exercise price: $11.50
Conversion ratio: 10:1
Call warrant price: $ 0.20
Scenario 1: In the money
If share price on the expiry date is $14.50, there is a positive difference of $3.00 (the difference between the final share price and the exercise price).
Given that the conversion ratio is 10:1, the difference must be divided by the conversion ratio, and the warrant price should be worth $0.30 at expiration.
For every 1 warrant purchased, the investor stands to make $0.10 (difference between final and initial warrant price). This translates to a 50% profit.
If the investor bought 1 lot of the share instead, the profit would have been $2.50, or a 20.8% growth in his investment.
Scenario 2: Out of money
If the share price trades at or below $11.50 (exercise price) on the expiry date, the warrant will be worth nothing upon expiration and the investment will be net value zero.
Scenario 3: Breakeven
The breakeven price of a call warrant can be calculated by taking the purchase price of the warrant multiplied by conversion ratio plus the exercise price. In this case, it is
$(0.20 x 10) + $11.50 = $13.50.
Scenario 4: Trading the warrants
Investors do not need to hold the warrants till maturity as this can be used as a short term trading instrument.
An investor may have noticed a technical buy signal on City Development shares on August 29 and wish to take advantage of this possible short term opportunity in price movement. The investor can either buy some City Development shares or buy a call warrant.
City Development shares were SGD 8.65.
DBS Citidev warrants were SGD 0.33.
On September 15, the investor may have noticed a technical sell signal and therefore take profit on his investments.
City Development shares were SGD 9.10.
DBS Citidev warrants were SGD 0.415.
From August 29 to September 15, City Development shares moved up 5.2% while the call warrants issued by DBS Bank on City Development shares issued by DBS Bank moved up 25.76%.
Put Warrants
A put warrant gives the buyer the right but not the obligation to sell the underlying asset at a predetermined price, called the strike or exercise price, on or before a predetermined date called the expiry date.
An investor would buy a put warrant with a view that the prices of the underlying asset will fall during the lifetime of the warrant. This would translate into a fall in warrant price as well.
When a put warrant expires, if the current price of the underlying instrument is lower than the exercise price of the warrant, the put on the warrant will be automatically exercised and the holder of the warrant will receive cash.
The amount of cash received will be the difference between the current price of the underlying asset and the exercise price of the warrant after adjustment due to the conversion ratio.
For example:
Share price: $10.00
Exercise price: $10.50
Conversion ratio: 10:1
Put warrant price: $ 0.15
Scenario 1: In the money
If share price on the expiry date is $8.50, there is a positive difference of $2.00 (the difference between the final share price and the exercise price).
Given that the conversion ratio is 10:1, the difference must be divided by the conversion ratio, and the warrant price should be worth $0.20 at expiration.
For every 1 warrant purchased, the investor stands to make $0.05 (difference between final and initial warrant price). This translates to a 33% profit.
If the investor sold 1 lot of the share on the start date instead and bought it back on the expiry date, the profit would have been $1.50, or a 15% growth in his investment.
Scenario 2: Out of money
If the share price trades above $10.50 (exercise price) on the expiry date,
the warrant will be worth nothing upon expiration and the investment will be
net value zero.
Scenario 3: Breakeven
The breakeven price of a put warrant can be calculated by taking the exercise price less the purchase price of the warrant multiplied by conversion ratio. In this case, it is
$10.50 - $(0.15 x 10) = $9.00.
Scenario 4: Trading the warrants
Investors do not need to hold the warrants till maturity as this can be used as a short term trading instrument.
An investor may have noticed a technical sell signal on Venture Corp shares on April 12 and wish to take advantage of this possible short term opportunity in price movement. The investor can either sell some Venture Corp shares if he owns any or buy a put warrant.
Venture Corp shares were SGD 14.00.
DBS Venture warrants were SGD 0.385.
On April 19, the investor may have noticed a technical buy signal and therefore take profit on his investments.
Venture Corp shares were SGD 13.10.
DBS Venture warrants were SGD 0.42.
From April 12-19, Venture Corp shares moved down SGD 0.90. Had the investor gone short on the shares, he would have had a potential 6.4% profit on the shares. Investing in the put warrants on Venture Corp shares issued by DBS Bank would have given the investor a 9.09% profit on his investment.