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Published January 29, 2007 
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Interpreting warrants information
By R SIVANITHY
BY MOST accounts, the Singapore Exchange (SGX) is studying ways to improve transparency in the warrants segment via enhanced disclosure on the part of issuers. This can only be good for the market - the more information retail investors have, the better their decision-making.
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Combining market- making volume and open interest provides early warning signals on which warrants have distortions surrounding them |
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However, in order to derive the maximum benefit from any new measures that might be introduced, it is essential for players to not only have more information but also to know how to interpret this information.
Most of the discussion recently has centred on requiring issuers to disclose two things - the amount of warrants they bought and sold on any given day as part of their market-making duties, and the number of warrants they are still holding relative to the issue size (or open interest).
The first bit of information is useful because it tells the public the proportion of daily volume that was generated by market-making activity and the proportion that came from other sources.
If market-making volume is insignificant relative to total volume, this means that there are many other players 'piggy-backing' on that warrant. This, in turn, would suggest that the warrant's price may not necessarily follow the issuer's pricing model, which in most cases is a variation of the Black-Scholes option pricing model.
By extension, retail players could then use this information as a red flag that significant distortions are associated with that warrant, in which case it might be worth avoiding.
Similarly, open interest. Disclosing the number of warrants held by the issuer vis-a-vis the original issue size is very useful information because if the number of warrants in public hands is significant, then the same conclusion as above applies - namely, that sizeable distortions could be present and the market maker or issuer might be unable to set transparent or theoretically correct prices.
Combining the two bits of information - market-making volume and open interest - thus provides the public with early warning signals on which warrants have distortions surrounding them and, therefore, might display unusual behaviour and so would be worth avoiding.
One issuer, SG, actually recognises the usefulness of open interest information and currently posts a newsflash on its website advising investors to seek alternatives when an issue is significantly in public hands because market forces may then affect prices. This is a useful service which others may wish to consider.
As an interesting side topic, the notion that often, significant turnover is generated by non-issuers and that the market could interfere with the price-setting process might come as a surprise to some observers who believe that issuers exercise constant control over prices and manipulate this to their advantage.
When the SGX does revamp disclosure in the warrants segment and provided the average investor understands how to interpret the additional information, this notion should finally be laid to rest. |
Dear Investors,
Macquarie is pleased to host its first series of Warrant Seminars for 2007. These free seminars are a great way to improve your warrants knowledge and cater to both new investors as well as more experienced warrant traders.
They will be conducted in a two part educational series by Mr. Barnaby Matthews (Head of Warrants, Singapore), who has more than 8 years experience in warrant markets.
1) Introductory Seminar - What is a warrant? Date: Thur, 1 Feb 2007 Time: 6:45 pm - 8:15 pm
2) Advanced Seminar - How To Trade Warrants Date: Thur, 8 Feb 2007 Time: 6:30 pm - 8:00 pm
Venue: SGX Auditorium, 2 Shenton Way, SGX Centre 1, Level 2 (opposite Lau Pa Sat)
Macquarie's warrant seminars are always popular and will fill up fast. Please reserve your seats early to avoid disappointment!
Register online at www.warrants.com.sg
Warmest regards,
Macquarie Singapore Warrants Team
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Published January 2, 2007
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Mitigating warrant risks
By R SIVANITHY
ONE of the most often-heard criticisms of trading warrants is that it is very risky. This much is true to some extent - like any stockmarket instrument, there is always risk of loss. But it is also not true to say that the risks are so great that trading the instrument should best be left to only full-time, professional players. Often, the risks associated with warrant trading are exaggerated because of ignorance or insufficient understanding.
To be honest, as long as traders observe certain strict rules when dabbling in warrants, they can minimise the likelihood of painful losses.
The first and most important rule is to use leverage prudently.
Suppose, for example, a stock costs $1 and it has a call warrant written on it that costs 20 cents, thus offering five times gearing or leverage. This means that in order to gain exposure to $1,000 worth of shares, a trader need only buy one-fifth or $200 worth of warrants.
In this way, if the underlying market never performs during the warrant's tenure, the loss is limited to $200 and not $1,000. The problem of course, is that most players tend to buy $1,000 worth of warrants instead of $200, thus actually exposing themselves to $5,000 worth of shares, a much riskier position which they may not necessarily have wanted to assume had they been fully conversant with how to use gearing properly.
A second golden rule is: be aware of the value of time.
Many small players still view warrants as 'buy-and-hold' instruments instead of the short-term trading instruments they really are. The reason they have short life spans is because issuers are unable to hedge their risks over an extended period. As such, time plays a big part in daily pricing and once time starts to run out, the depreciation in warrant value can be swift.
As a rule of thumb, punters should aim to trade warrants mainly during the first two to three months of their life and try to avoid them at least six weeks before expiry. (More advanced traders might want to look up the warrant's theta which should be provided at each issuer's website, theta being a measure of the warrant's sensitivity to time decay.)
A third rule is that if you are bearish on a stock, buy put warrants and do not short-sell calls.
Short-selling of any sort in the warrants market should be avoided at all costs, especially calls, because it exposes the trader to theoretically unlimited losses.
Perhaps most important of all though, is: trade only when you have a view on the underlying stock.
Many warrant participants have no idea where the underlying shares are headed over the next few days or weeks and buy warrants because they are cheap or low-priced or look like they are about to move. This may work occasionally but to trade with no opinion about the merits or demerits of the underlying shares can be a recipe for disaster.
The structured warrants segment has come a long way since it was revived for a third time in 2003, with 2006 seeing all previous records broken in terms of volume traded and number of underlyings on which warrants were issued.
Robust markets undoubtedly played a part - the Straits Times Index for example, gained a sterling 27 per cent last year, far surpassing all prior expectations while China (especially its banks) and Hong Kong also turned in superior performances.
Meanwhile, property stalwarts like CapitaLand weighed in with an amazing 82 per cent rise for the year, so it is no surprise that its associated warrants were consistently the local market's most popularly traded instrument.
Hopefully, 2007 will see the market continue to grow and progress as it did in 2006. Observing a few simple rules such as those listed here should help. |
very interesting, tink we shld post all warrant acticle on this thread.
Published December 1, 2006, Hock Lock Siew
How warrant issuers treat dividends
ONE area that retail investors have great difficulty with when trading warrants is the correct treatment of dividends. To be honest, dividend adjustments can be confusing and, often, investors are puzzled by what they perceive as anomalies in pricing which were simply due to dividend adjustments.
To avoid confusion, issuers should post on their websites details of how adjustments are made since similar adjustments are needed for bonus or rights issues.
It's important to note right at the start that in a properly functioning market, all stock prices should already incorporate some estimate of future dividends.
In fact, when a warrant is first issued, the pricing model used by issuers will take into account an ordinary dividend payment if one is expected some time during the warrant's life span. Thus, if the company actually pays this amount as forecast, there will be no change to the warrant's price.
In this straightforward case, the intrinsic value of a call, for example, is calculated based on (share price minus forecast dividend minus exercise price).
Let us assume a company's shares trade at $2, and there is a call warrant in issue which converts one-for-one into the shares at an exercise price of $1. Also suppose that the company has traditionally paid a 10 cents ordinary dividend and there is no reason to expect any alteration to this amount in the foreseeable future.
The intrinsic value of the call will, therefore, be 90 cents, which is ($2 (share price) minus 10 cents (forecast dividend) minus $1 (exercise price)). (There will, of course, be a time value attached to the warrant, so it will sell for more than 90 cents, but we'll stick to using just intrinsic value for now).
After the stock trades ex-dividend, the share price should drop to $1.90 ($2 minus 10 cents). Because there is no further dividend expected, the intrinsic value of the warrant remains at 90 cents, which is ($1.90 minus zero forecast dividends minus $1). Warrant holders are therefore not worse off.
Adjustments needed
Confusion arises, however, when ordinary dividends are different from the forecast, or when a special dividend is paid. Stated differently, if there is an alteration to the anticipated cash outflow from the company, adjustments will be needed. Suppose now that instead of 10 cents, the company surprises the market and pays only 5 cents, resulting in an ex-price for the shares of $1.95 rather than the anticipated $1.90. In this case, the warrant's intrinsic value is 95 cents and not 90 cents and, therefore, its price is adjusted upwards by 5 cents. Conversely, if the ordinary dividend was 15 cents instead of 10 cents (that is, more than anticipated), the warrant's intrinsic value and price will decrease by 5 cents.
In other words, if the dividend payout is less than expected, the warrant holder benefits because the value of the firm rises and because the pricing model had earlier overstated the dividends.
Conversely, if the company pays out more than expected, resulting in a larger-than-expected decline in the value of the firm, warrant holders will be worse off because not only are they not entitled to the dividends but the intrinsic value of their warrants will have to be adjusted downwards.
Intuitively, the same logic should apply when a special dividend is paid because the value of the firm drops by a larger-than-expected amount, resulting in an erosion in the warrant's intrinsic value.
Issuers, however, are an equitable bunch. When a special dividend is paid, issuers will attempt to ensure that, as far as possible, warrant holders are not disadvantaged.
Note that this phrase can take on different interpretations, but the generally accepted one is that the price of the warrant should remain unchanged after the special payment.
To accomplish this for a call, issuers thus lower the exercise price and adjust the conversion ratio.
Net effect
Intuitively, these changes should be proportionately similar to the loss in value of the firm from the special dividend. In practice, this is the case.
The net effect is that the warrant's price remains unaffected after the special dividend is paid, which is the fairest way of compensating warrant holders for the unexpected drop in share price.
To avoid confusion, issuers should, therefore, consider posting details of how these adjustments are made on their websites to enable a better understanding of these calculations, especially since similar adjustments in principle are needed for bonus or rights issues.
