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Cash Extraction Strategy Using Warrants

Maintain exposure, protect losses
Given the current volatile market, some investors could be looking for ways to protect the downside of their stocks portfolio without forgoing a potential market rebound. One of the ways is by using a “Cash Extraction” strategy. The strategy involves investors selling some of their stock portfolio and buying warrants to maintain similar exposure.

Let’s look at a hypothetical example.
Call Warrant W ($0.20) tracks the underlying share S ($2.00) and has an effective gearing of 5 times. In other words, for every 1% share price movement of S, the warrant W should rise/fall by approximately 5%.

The investor has 10,000 shares of S worth $20,000 and expects a rebound of 5% on the share S to $2.10 within a short period. This will give him a gain of $1,000. He/she could get a similar exposure by selling his stocks and buying 20,000 call warrants for a price of $4,000. Given an effective gearing of 5 times, the warrants should rise by approximately 25% to $0.25. Thus, earning similar gains of $1,000 for the investor.

If the shares S fall to $1.00, the investor may have lost $10,000 if he/she held on to the shares. If he/she has applied the cash extraction strategy, the maximum loss is the call warrant investment of $4,000.

Important note
Please note that warrant is a derivative product and is not an exact replication of stocks (eg not eligible for dividend payments). Warrant investing involves risks. Investors should consult their broker or remisier before executing any strategies.

Macro announcements this week
Mon 26 Sep: SG Industrial Production (Aug), US New Home Sales (Aug)
Tue 27 Sep: US Consumer Confidence (Sep)
Wed 28 Sep: US Durable Goods Orders (Aug)
Thu 29 Sep: US GDP (2Q), US Initial Jobless Claims, US Pending Home Sales (Aug)
Fri 30 Sep: PRC HSBC Manufacturing PMI (Sep), US Personal Income (Aug), U of Michigan Confidence (Sep)

The following are Macquarie’s STI call and put warrants listed on Friday:

Code	Name	Type	Expiry	Exercise Price
O4ZW	STI 2800MBeCW111230@	Call	30-Dec-11	2800
O4YW	STI 3000MBeCW111230@	Call	30-Dec-11	3000
O4XW	STI 2700MBePW111230@	Put	30-Dec-11	2700
O4WW	STI 2900MBePW111230@	Put	30-Dec-11	2900

Why You Need to Switch Warrant Strikes in This Market

As broad indices refurbish new recent highs and stock prices break into new price territories, warrant investors may find that the warrants they previously traded may no longer be suitable. It is thus important that warrant traders consider switching into other warrants to maintain their gearing as market conditions change.

Importance of switching strikes
With spiking stock prices, many call warrants would have moved further in-the-money (and put warrants out-of-the-money). In some cases, many of these warrants may no longer be on tight spreads as a result of becoming deep-in-the-money. Usually with deltas above 80%, issuers widen their offer spread on these warrants and the bid/offer volume may be reduced as they are no longer willing to sell large volumes of such warrants.

An example to illustrate the above can be seen via an IndoFood Agri warrant IndoAgriMBLeCW101102 (LD4W), exercise price $2.20. When IndoFood Agri surged 7% to $2.45 yesterday, all IndoFood call warrants moved further in-the-money. In the case of IndoAgriMBLeCW101102 (LD4W), exercise price $2.20, as the share price jumped to $2.45, the delta on this warrant also rose to 90%. The offer price on the warrant was thus widened, with the warrant now trading on a one cent spread. Offer volumes were also reduced to just 50 lots from the 150 quoted on Friday when stock price was lower.

In such instances, warrant holders and traders looking to take or maintain a leveraged view on IndoFood may consider switching or rolling their position into another warrant of a higher strike such as IndoAgriMBLeCW110201 (L6HW), exercise price $2.50 which will provide a higher effective gearing.

With stock prices moving up fast, investors may have noticed widening spreads and reduced volume in certain warrants over various names, including SGX, Wilmar, UOB, Genting etc. Hence, this strategy of switching into warrants of a different strike as a result of moving prices and changing market conditions is not limited to just IndoFood but should be applied to all underlyings. Macquarie regularly renews warrant issuance over stock underlyings to provide investors with new warrants to switch into as share prices move.

* For a full list of Macquarie warrants over different underlyings, investors can do a Warrant Search at http://www.warrants.com.sg/en/warrants/search_e.cgi

## pUt warrants ##

Singapore's Growth - Taking a Breather this Quarter?

Investors with a bearish view on Singapore's prospects and the stock market can leverage on their view through Macquarie's list of put warrants over various underlyings:

Put CapitalaMBLePW110201 (L0ZW) exercise price $4.00.*
Put DBS MBL ePW101202 (LF0W) exercise price $13.50.*
Put GentingSMBLePW110201 (L6FW) exercise price $1.80.*
Put SembMar MBLePW110103 (LS6W) exercise price $3.80.*
Put UOB MBL ePW110202 (L6RW) exercise price $19.00.*

The Singapore government will release its advance estimate of 3Q10 GDP growth and the MAS should release a policy statement after its semi-annual review of monetary policy date settings. In the meantime, Macquarie Research Equities (MRE) has released a note stating its view on Singapore's growth outlook.

Factors that affect warrant pricing

Global markets continue to show volatility in the third quarter, with regional indices rebounding from earlier lows in general. Such movements present short-term opportunities for investors with a view on the market to engage in their respective positions through index warrants.

When choosing warrants, investors should be aware of the five variables that affect warrant pricing.

Underlying share price

This is the key driver of warrant price.

To choose warrants that offer better sensitivity, investors should avoid choosing far out-of-the-money warrants as its relatively low delta would result in lack of sensitivity of the warrant to underlying movements.

Volatility

The higher the volatility, the greater the risk on the underlying shares and therefore the more expensive the warrant will become. A change in volatility is likely to impact warrant pricing. Choosing warrants with medium to long tenor and closer at-the-money helps ensure that the influence of changes in implied volatility is lessened.

Time to expiry

The greater a warrant’s tenor, the higher its value, this is because the warrant has more time to trade. Time decay is a factor investors need to consider as it would lead to a decrease in the warrant price on a daily basis.

Dividends

Warrants investors do not receive the dividends paid on the underlying shares. However, in valuing warrants, the issuer will estimate the expected dividend stream. This means that warrants do not dramatically fall in price when the underlying share trades after the dividend of the underlying shares have been distributed.

In the case where there is a rights issue or special cash, the terms of warrants (strike and divisor) are adjusted to accommodate the changes that may arise from these issues so that the warrant investor is not prejudiced.

Interest Rates

For each call warrant issued, the issuer allocates funds to purchase underlying shares. If the cost of borrowing (the interest rate) increases, this will be reflected as a corresponding increase in the warrant price.

Similarly, a put warrant will decrease in value when interest rates rise.

For detailed information on warrants, visit www.dbwarrants.com.sg.

HIGHEST STRIKE PRICE

S$2.50

WORST DEAL

BEST DEAL STRIKE PRICE *S$1.15* ONLY

pharoah88 ( Date: 21-Sep-2010 11:44) Posted:

Tuesday: 21 SEPTEMBER 2010

Macquarie is pleased to list the following new warrants this morning:

Call GentingSMBLeCW110303 (L7JW) exercise price $2.25.*

Long dated GentingSMBLeCW130104 (L7KW)

exercise price $2.50.*

Call MIDAS MBL eCW110303 (L7LW) exercise price $1.05.*

Call SGX MBL eCW110303 (L7MW) exercise price $8.50.*

Land of the rising sun

Despite current uncertainty over the global recovery, most markets around the world showed gains for the third consecutive week last week, with many Asian markets also trading well.

At the end of Thursday, the week-on-week comparison saw the MSCI World Equity Index rose by 1.6 per cent to close at 1,157 points while the MSCI Asia-Pacific ex Japan Index closed at 430 points, an increase of over 2 per cent. Commodity prices were up too:

The Dow Jones UBS Index rose 1.4 per cent to close at 135 points.

The Japanese government’s intervention in the forex markets had caused the Yen to drop to its lowest against the US dollar in 22 months. This dip has spurred the Japanese market to rise to its highest in six weeks — the best performance by the Nikkei this year.

Japan has also put in a rather consistent performance economically.

Capital expenditure for the second quarter of 2010 grew faster than expected, pushing up the gross domestic product for the country. Core private sector machinery orders, regarded as a leading indicator of capital spending, rose 8.8 per cent in July — notably more than the initially expected 1.8 per cent.

Government subsidies and incentives continue to drive domestic consumption, as manufacturers’ orders climbed 10.1 per cent in July. Economic data also showed that orders from the services sector grew 8.1 per cent — the first increase in three months — a sign of a stabilising domestic demand.

The Japanese government’s intervention in the Yen showed that they are able and willing to support the recovery of its economy. Hence, the Japanese equity market might continue to react positively.

Technical analysis also supports the recovery in the Japanese market.

Both the Moving Average Convergence-Divergence and Stochastic indicators point to the recovery of the Nikkei. Momentum for the uptrend is also building steadily.

With the uptrend currently in place, we can expect further gains in the Japanese market in the months to come.

However, as there will still be expected volatility from concerns over the recovery of the world economy,

The Singapore market has been on the uptrend over the past week and looks to continue into the coming week. With that in mind, investors should buy stocks that are still lagging slightly behind the general rally for greater upside potential. These include Ezra, Wilmar and NOL, which seem to have good upside potential. Traders can use call warrants to leverage and extend their positions in those counters.

Visit www.siasresearch.com for daily market calls and investment strategies reports.investors interested in the Japanese market should consider Japan related Exchange Traded Funds such as the DBXT MSJAP 10US$, or the Lyxor Japan 10US$.

Contributed by Edmund Seow from SIAS Research.

Index warrants ins and outs

Hang Seng Index Warrants

Warrant Stock Type Strike

HSI 22000 MER ECW101029 ----- L5WW ----- Call ----- 22000

HSI 20500 MER EPW101029 ----- L5SW ----- Put ----- 20500

For more information, please visit www.mlwarrants.com.sg

A warrant is a leveraged product that can allow investors to achieve high potential returns with a small capital outlay.

It requires investors to have a strong view of the market at a specific time horizon. Investors generally prefer warrants with high turnover as they believe that warrant turnover is an indication of where the market focus lies.

A Bloomberg report noted that there were 31 underlying assets related to warrants traded on the Singapore Exchange (SGX) as of September 6. Of these, warrants related to Hong Kong’s Hang Seng Index (HSI) have the highest turnover in Singapore, as compared to warrants with other underlying assets.

According to Reuters and Bloomberg, HSI-related warrants accounted for approximately 53.4 per cent of the total warrants turnover in Singapore from Sept 1 to 7; and 39 of the 217 warrants traded on the SGX as of Sept 7 were related to the HSI.

Tenor and effective gearing

From Sept 1 to 7, more than 90 per cent of actively-traded HSI warrants are those with shorter tenor, where the time to expiry is less than 60 days. The effective gearing of these warrants ranges from 11 to 22 times. Effective gearing is an estimate of how much the warrant price would change in percentage terms for a 1 per cent change in the share price.

As the HSI ended 2.5 per cent lower in August, an investor can enjoy potential capital gains if he bought put warrants. Investors trading short-dated warrants should be mindful of the impact of time decay on the value of warrants.

Another characteristic of HSI warrants is its bid-ask spread, which is comparatively tighter than other warrants.

As the index has good liquidity, warrant issuers are able to provide a tight spread.

Sensitivities Watch

When trading index warrants, investors should find out about the sensitivity of the warrant price to changes in the index in order to understand the potential upside and downside.

Warrant sensitivities watch is indicative and is based on the index trading around the specific Hang Seng index level, which is referenced to the closing level on the last day. Warrant prices are likely to change with movements in the index and changes in implied volatility.

Thursday: 9 SEPTEMBER 2010 11:07am

MARKET MAKER nOt pOstIng bId for

GentingSMBLeCW120402 ?

WHY ?

WHY ?

WHY ?

WHY ?

Genting SP	G13	i	--	SGD	1.810	-0.010	-0.5	21,292,000	3,215,000	1.800	1.810	2,529,000	1.830	1.820	1.840	1.790	M	--	SGX	G13	GENS.SI
GentingSMBLeCW120402	J2UW	i	--	SGD	0.220	0.000	0.0	20,000	5,000	0.200	0.220	212,000	0.220	0.220	0.220	0.220	M	--	SGX	J2UW	GNML_td.SI
GentingSMBLeCW130103	L2PW	i	--	SGD	0.160	-0.005	-3.0	100,000	800,000	0.160	0.165	1,050,000	0.160	0.165	0.160	0.160	--	--	SGX	L2PW	GNML_tm.SI
GentingSMBLeCW130603	L0QW	i	--	SGD	0.220	0.000	0.0	5,000	300,000	0.215	0.220	300,000	0.220	0.220	0.220	0.220	M

GentIngSMBLeCW130103 is the mOst eXpensIve warrant fOr GENTING SP

because it has the HIGHEST STRIKE PRICE S$1.800

and EXPIREY is actually in 2012 December and nOt in 2013.

Warrant Stock Type Strike EXPIRY RANKING

GentingSMBLeCW110202 (L2LW) ----- Call ------- $1.60 ----- 2011 JAN DC

GentingSMBLeCW110201 (L6CW) ----- Call ------- $1.85 ------ 2011 JAN DC

GentingSMBLePW110201 (L6FW) ------ Put ------- $1.80 ------ 2011 JAN

GentingSMBLeCW130103 (L2PW) - LD Call* ----- $1.80 ----- 2012 DEC CB GOOD

GentingSMBLeCW120402 (J2UW) - LD Call* ----- $1.15 ----- 2012 MAR AB BETTER

GentingSMBLeCW130603 (L0QW) - LD Call* ----- $1.40 ----- 2013 MAY BA BETTER

LD = [Long Dated]

Wednesday: 8 SEPTEMBER 2010 4:30pm

nOt makIng market FAIRLY fOr

GentingSMBLeCW120402

J2UW

cOmpare bId and Offer prIce SPREAD

pharoah88 ( Date: 08-Sep-2010 16:53) Posted:

MARKET MAKING UNFAIRNESS

GentingSMBLeCW120402	J2UW	i	--	SGD	0.220	+0.025	+12.8	110,000	20,000	0.205	0.220	232,000	0.205	0.195	0.220	0.205	M	--	SGX	J2UW	GNML_td.SI
GentingSMBLeCW130103	L2PW	i	--	SGD	0.165	+0.005	+3.1	808,000	1,130,000	0.160	0.165	800,000	0.170	0.160	0.170	0.165	--	--	SGX	L2PW	GNML_tm.SI
GentingSMBLeCW130603	L0QW	i	--	SGD	0.220	+0.005	+2.3	135,000	300,000	0.215	0.220	300,000	0.225	0.215	0.225	0.220	M

MARKET MAKING UNFAIRNESS

GentingSMBLeCW120402	J2UW	i	--	SGD	0.220	+0.025	+12.8	110,000	20,000	0.205	0.220	232,000	0.205	0.195	0.220	0.205	M	--	SGX	J2UW	GNML_td.SI
GentingSMBLeCW130103	L2PW	i	--	SGD	0.165	+0.005	+3.1	808,000	1,130,000	0.160	0.165	800,000	0.170	0.160	0.170	0.165	--	--	SGX	L2PW	GNML_tm.SI
GentingSMBLeCW130603	L0QW	i	--	SGD	0.220	+0.005	+2.3	135,000	300,000	0.215	0.220	300,000	0.225	0.215	0.225	0.220	M

MARKET MAKING GAP

Genting SP	G13	i	--	SGD	1.780	-0.020	-1.1	140,659,000	13,295,000	1.770	1.780	7,174,000	1.820	1.800	1.830	1.770	M	--	SGX	G13	GENS.SI
GentingSMBLeCW120402	J2UW	i	--	SGD	0.215	+0.010	+4.9	249,000	1,000	0.215	0.220	220,000	0.215	0.205	0.220	0.210	M	--	SGX	J2UW	GNML_td.SI
GentingSMBLeCW130103	L2PW	i	--	SGD	0.160	0.000	0.0	245,000	1,300,000	0.155	0.160	800,000	0.165	0.160	0.165	0.160	--	--	SGX	L2PW	GNML_tm.SI
GentingSMBLeCW130603	L0QW	i	--	SGD	0.205	0.000	0.0	310,000	590,000	0.200	0.205	300,000	0.210	0.205	0.215	0.200	M

Time decay and other effects on warrants
The leverage effect of warrants and its exposure to a range of foreign and local sectors and markets make it attractive for investors who want to expand their investment portfolio, with a small initial outlay.
Warrants are usually priced at a fraction of the share price, using the leverage effect to result in a larger percentage gain, even at a small percentage share price gain. There are also index warrants that track emerging underlying markets, giving exposure to these less accessible markets for investment opportunities.
However, before investors dive in, pay heed to the time decay on warrant prices, as noted by BNP Paribas.
Like all types of options, the price of a warrant declines daily, if all factors such as underlying level, implied volatility, etc, stay unchanged. This is called time decay. Investors face a trade-off when they consider warrants:
Gain leverage over time decay.
For example, an investor buys a call warrant XYZ on Stock W, which is currently trading at $10, with an Out-Of-The-Money strike price of $12.
The warrant price is $0.25, with a one year expiry.
Assuming an effective gearing of 8.7x and steady implied volatility at 22 per cent, if the price of Stock W rises to $11 six months from now, merely multiplying the underlying percentage change by the effective gearing would give a 87 per cent increase in value.
However, the warrant price will only rise 14 per cent in value to $0.285 because of its time decay of $0.00113 per day over 180 days.
Despite this, its increase of 14 per cent is still greater than the stock price’s 10 per cent. In that sense, it is still better than trading the stock directly.
If the price of Stock W remains unchanged at warrant XYZ’s expiry, XYZ would expire worthless.
In this case, paying the six-month time decay will make an originally profitable trade (buy at $0.25 and sell at $0.285 six months later) a total loss as XYZ expires Out-Of-The-Money with Stock W below the strike price.
Time decay will add to the loss in value of a warrant if its underlying movement is unfavourable. When it is favourable, it will reduce the profit in the value of the warrant.
Time decay is the most severe when a warrant is near its expiry, and when its underlying price is trading very close to the strike price. Investors who pick a short-term warrant for its high effective gearing, incur a higher risk of loss if they had made the wrong call, plus time decay.
Long-term warrants may be a wiser choice, even with lower effective gearing. If the market goes against the investors, the loss will be less than that of the short-term warrant.

Long-term warrants have less time decay, and its price will shrink less closer to the expiry date.

Hear hear.

iPunter ( Date: 12-Aug-2010 13:25) Posted:

Warrants are for seasoned 'lao jiao' ('lao niao')...

Stick to cash play, or use CFD, to simplify your stock market life... Smiley

zhangwuji ( Date: 12-Aug-2010 11:41) Posted:

Hi,

Newbie here. I am looking into using warrant to hedge against my long position in STI ETF. Any suggestions?

Thanks.

Charting the recovery in India

Uncertainty in the American market and the fear of a global slowdown in recovery spurred many equity markets around the world to decline over the past week.

The MSCI World Equity Index ended Thursday at 1.5 per cent lower week on week to close at 1,077 points.

Bourses in Asia weakened and the MSCI Asia-Pacific ex Japan index closed Thursday at 400 points, down 1.8 per cent week-on-week.

In our earlier commentary dated June 21, we spotlighted India’s growth momentum. Since then, the CNX Nifty Index — one of the country’s key indices — rose by approximately 4 percent, from 5,262 points to 5,477 points last Thursday.

The recovery was spurred on by its strong economic performance. India‘s exports rose 13.2 per cent year on year after recording its ninth consecutive month of growth in July. Robust corporate profits, growing investments due to favorable financing conditions and the International Monetary Fund’s revised growth projection from 8.8 per cent to 9.5 per cent also contributed.

While the withdrawal of advanced countries’ stimulus measures might impact demand, it appears that the country is still on track to reach its 2010 fiscal year export target of US$200 billion ($265.2 billion).

The consistency of the recovery of India’s stock market looks set to continue through the second half of the year.

While the CNX Nifty underwent some consolidation over the last week, the market is ripe for continued recovery and technical signals are pointing to an end of the current downtrend.

As such, investors who are interested in the India market should explore buying into Exchange Traded Funds such as the DBXTNifty 10US$ and the Lyxor India Nifty 10 — both of which track the Nifty Index, and the IS MSCI INDIA 100US$ which tracks the MSCI India Index.

Traders who are looking for opportunities in the Singapore market can look out for call warrants on stocks that have been resistant to sell offs on the Straits Times Index.

Stocks such as Noble Group and Wilmar seem to have bottomed out last

Visit www.siasresearch.com for daily market calls and investment strategies reports.week and leveraged longs using call warrants would allow traders to take advantage of the volatility in the market for quick trades.

Contributed by Edmund Seow from SIAS Research.

Warrants have a limited shelf life...

    If OOTM and near expiry, they will become rotten fruit...

        But it is a good gambling tool, though.

           Anyway, no matter how we play the stock market,

               all is still betting... Smiley

iPunter, thank you for your comment.

"sin jiao" will eventually becomes "lao jiao" one day( as long as you take care not to loss your "lan jiao"). Smiley

Buy/sell buy/sell strategy incur high cost. It is no difference from gambling in casino. I don't mind spend some gained dividend buying some insurance. The problem is that most warrant tenure is too short. Only 6 months( am I right?).

Warrants are for seasoned 'lao jiao' ('lao niao')...

Stick to cash play, or use CFD, to simplify your stock market life... Smiley

zhangwuji ( Date: 12-Aug-2010 11:41) Posted:

Hi,

Newbie here. I am looking into using warrant to hedge against my long position in STI ETF. Any suggestions?

Thanks.

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TRADING < WARRANT >