Short-term play on stock moves at cheaper entry level
Stock warrants are similar to stock options in that they allow investors to profit from a rise in an issue's share price for a fraction of what it would cost to purchase the underlying stock.
An investor can buy some warrants for as little as 10 per cent of the market price of the underlying stock. The investor makes money if the stock rises past a higher exercise price before the warrant expires. The potential risk is that the underlying stock will never rise to the exercise price before the end of the contract.
Because warrants pay no dividend, and have a limited shelf life before they expire, they are considered a shorter-term investment.
'We advise clients not to put all their money in warrants. Use it as part of the portfolio. Keep it at less than 10 per cent of your entire portfolio,' Edmond Lee, director of equity derivatives at Societe Generale, says.
The key differences are that warrants are issued by private third parties such as banks, instead of by an exchange. Warrants also typically have longer lifetimes than options, and they are not standardised as options are. This means that three different banks can issue three different types of warrants on the same underlying stock.
The key elements of a warrant are the price, or premium, which the buyer pays the issuer for the right to buy the underlying shares at a fixed price at some time in the future; the expiration date, by which you have to exercise, or use, your option to buy the underlying shares; and the gearing, or multiple of exposure that the premium gives you, compared with the exposure if you were buying the shares directly.
The lower the volatility of the underlying stock, the cheaper the warrants should be because the issuer takes less risk on the direction the stock will move. Also, shorter-term warrants tend to be cheaper than longer-term warrants as the issuer is taking a shorter-term risk. How close the exercise price is to the current price of the underlying stock also affects pricing.
Most warrants issued in Hong Kong are cash-settled, which means that growing warrant issuance does not lead to dilution of the underlying stock.
