Warrants

Tutorials

How to choose the right warrant

There are hundreds of warrants listed on the Singapore Exchange and it is common for there to be more than one warrant on each underlying stock. Before deciding on which warrant to invest in, a potential investor may consider the following pointers before taking the plunge in the universe of warrants.

Step 1: Know the Product
Investors should understand the dynamics of how the product works and the associated risks before buying any investment.

Step 2: Have a view on the where the Market is headed
The performance of warrants is tagged closely to the price performance of the underlying asset. An investor with a bullish view on the underlying asset would consider buying a call warrant and the converse is true of a put warrant where the view is a bearish one.

Step 3: Determine an Investment Target
Any investor may choose to set a deadline for the underlying asset to reach a target price. If the underlying asset fails to reach the target price, the investor should reevaluate his positions. Warrants are subject to time value decay and the closer a warrant is to its expiration date, the less it is worth.

Step 4: Select the best warrant
Every warrant is unique - it has a unique exercise price, maturity date and effective gearing level. Investors should choose a warrant in light of his investment targets and objectives and continually be monitoring his risk/return profile.

To differentiate one warrant from another, here are the other variables one should consider:

Premium

Premium is often the indicator used to value warrants. It is the percentage amount by which the cost of acquiring the underlying asset through the exercising of the warrants exceeds the cost of buying the underlying asset directly, in return for which the investors get the gearing effect for the warrants.

It can be represented by:

Call Premium

Put Premium

However, this method is not always accurate when comparing different warrant issues. To accurately assess different warrants, investors need to take the premium relative to each warrant's lifetime i.e. premium / remaining lifetime.

Example: Call warrant on XXX Ltd.

Price of XXX Ltd: $12.40
Exercise Price: $13.00
Remaining lifetime: 150 days
Price of call warrant: $ 0.21
Conversion ratio: 5:1

Call Premium	=
	=	13.31%

The premium on the warrant is 13.31% which implies that buying 1 lot of XXX Ltd shares using warrants is 13.31% more expensive than buying the share directly from the market.

However, each investor only needs a small capital when investing in warrants to participate in the price movement of XXX Ltd shares. The resulting gearing effect allows the investors to realize a higher percentage gain once the share price rises, as compared to a direct purchase of XXX Ltd shares.

Delta & Theta

Delta is an indicator that shows the absolute change in the price of the warrant, given one unit change in the price of the underlying asset.

Example:

Share price of AAA Co: $10.00
Price of share rose by $1.00
Current price of call warrant: $ 0.20
Current delta: 0.50
Conversion ratio: 10:1

Delta adjustment with respect to conversion ratio	=
	=	0.05

This implies that for every $1.00 change in the share price of AAA Co, the corresponding warrant price will change by $0.05, i.e. theoretical price of warrant is $0.25.

The deeper a warrant is in-the-money, the higher the delta will be. The converse is true for warrants that are out-of-money as the delta will be closer to zero.

Theta
Theta is the negative change in price of warrant with respect to change in the remaining lifetime of the warrant.

Warrants that are at-the-money are subject to time decay a lot more than warrants that are out-of-the-money, especially as the warrants approach expiration.

Gearing/Effective Gearing

Gearing refers to the extent to which a warrant moves in line with the underlying asset. A higher gearing level implies a higher potential profit for the investor when the market moves in line with the investor's objectives. Higher gearing also implies that the investor is subject to greater risk should the market move against the investor.

Gearing

Example:

Share price of XXX Co: $1.42
Price of warrant issued on XXX Co.: $ 0.20
Conversion ratio: 1:1

Gearing	=
	=	7.1 times

This implies that for a 1% rise of XXX shares, the corresponding call warrant will rise by 7.1 times. Gearing is often an indicator used for deep in-the-money warrants.

For warrants that are at-the-money or out-of-money, effective gearing is more commonly used.

Effective Gearing
Effective gearing is a measure of the actual gearing effect provided by the warrant that takes into account the delta of the option.

Example:

Share price of YYY Co: $12.50
Price of warrant issued on YYY Co.: $ 0.20
Conversion ratio: 10:1
Delta: 0.5

Gearing	=
	=	6.25 times

Effective gearing	=
	=
	=	3.125 times

Realistically, for every 1% rise on YYY shares, the corresponding call warrant will rise by 3.125 times.

Volatility

Volatility measures the extent to which the price of the underlying fluctuates in a given length of time.

A higher magnitude of the price fluctuations translates into a higher warrant price. This is because a sharp move of the underlying price would represent a higher probability that the underlying price would exceed or cross below the exercise price, depending on the type of option in question.

Summary of variables that influence the price of warrants

Variables	Changes to Variables	Call Warrant	Put Warrant
Underlying Stock Prices	Up	Up	Down
Strike Price	Up	Down	Up
Volatility	Up	Up	Up
Time to Expiration	Up	Up	Up
Dividends	Up	Down	Up