Big potential awaits, but leverage can be double-edged sword

PUBLISHED : Tuesday, 15 May, 2007, 12:00am
UPDATED : Tuesday, 15 May, 2007, 12:00am

Given the stellar growth of wealth management and private banking in the Asia-Pacific region, it should come as little surprise that Hong Kong has emerged as one of the three largest warrant markets in the world for the past five years, according to information provided by Citigroup Global Markets Asia.

In 2006, the total global warrants turnover was about US$230.4billion, an increase of 109 per cent on 2005. The 2006 amount comprises 28 per cent of the total Hong Kong market turnover.

Hong Kong also had the highest warrant turnover ratio of 47 per cent in 2006, which is the average daily warrants turnover as a percentage of the number of listed warrants.

Winston Choi Wang-yu, Citigroup's vice-president and head of warrants sales in Hong Kong, attributes the continuing growth of the warrants market to the increasing sophistication of retail investors, who were widening their scope of investment choice.

He also attributed the demand to Chinese companies accessing global liquidity by listing in Hong Kong.

'With dynamic and more volatile Chinese stocks like China Mobile, China Insurance, ICBC and PetroChina emerging on the Hong Kong exchange, investors [now] have a wider selection of stocks and warrants to choose,' Mr Choi said.

He said warrants were leveraged investments by nature, and could therefore offer the potential for attractive returns, adding that a common measurement for the leverage effect of a warrant was known as 'effective gearing'.

To explain this, Mr Choi gave the example of a warrant which had an effective gearing of seven times. This means that if the stock price of a company rises by 1per cent, the price of the warrant should move up by about 7 per cent, assuming that all other factors remained constant.

'However, investors must understand that warrant investing can be a double-edge sword and that leverage applies to both gains and losses,' Mr Choi said.

Despite the potential risks, there are also great rewards for dabbling in the warrants market, and Mr Choi recommended several ways individuals could seize the opportunities that the current Hong Kong warrants market offered.

Firstly, a potential investor should be familiar with the warrants' products and understand how to use and select them. Secondly, investors should be aware of the latest developments in the stocks and warrants market. Thirdly, investors should be familiar with what warrants are available in the market, and the specific terms which suit their particular view and situation. Finally, investors need to open a securities account with their bank or securities company to begin trading.

There are two different types of warrants - a 'call' warrant and a 'put' warrant. A call warrant represents a number of shares that can be purchased at a specific price, on or before a certain date.

A put warrant represents a certain amount of equity that can be sold back to the issuer at a specified price, on or before a stated date.

Mr Choi said the purchase of put warrants provided an easy way for investors to hedge their stock portfolios or to take advantage of a downside in the stock market.

'Instead of short selling the shares that would require heavy borrowing costs, collateral, and a special account, investors can buy put warrants in their standard securities account,' he said.

Mr Choi added that it was important to note that cash settled covered warrants were exempt from stamp duty in Hong Kong.

At a glance

A warrant is simply a securitised form of an option. It is listed on the stock exchange just like a share and can be traded using a standard securities trading account

A warrant or an option is a right to buy (call warrants) or sell (put warrants) an underlying asset (the stock or index) at a specific price (exercise price) at or before a specific date (expiry date)

As warrants provide leverage, an investor can obtain exposure to an underlying asset at a fraction of the cost of the underlying share itself

Because each warrant has an expiry date, the length of an investment in a warrant is limited to the term of the warrant

As warrants are listed on the stock exchange, they can easily be sold in the stock market before they expire