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Understanding Call Warrants

posted 3 Mar 2011, 20:02 by Zam Mlk

 
 
1.

What is a warrant?

 A warrant  is an option offered in the form of a security.  There are two basic types of warrants.  Warrants have a fixed tenure (maturity) and, if not exercised, are worthless after their expiry date.
 
  • A call warrant gives the holder the right to buy a given quantity of the underlying asset at a predetermined price (i.e. exercise or strike price) on or before a particular date (i.e. expiry date). 
  • A put warrant gives the holder the right to sell a given quantity of the underlying asset at a perdetermined price (i.e. exercise or strike price), on or before a particular date (i.e. expiry date).
2.What are covered warrants?
 Covered warrants (or structured warrants) are issued by a company (usually a bank or securities firm) on shares of another listed company, basket of shares or an index.
 In Malaysia, only covered call warrants (or "Call Warrants" under the SC’s Guidelines for the issue of Call Warrants) in the form of "fully-collateralised" or "non-collateralised" Call Warrants are currently permitted to be issued by authorised banks or universal brokers approved by the SC. Put Warrants are not yet permitted under the Guidelines.
  
3.What are the major differences between Call Warrants and Company Warrants?
 
 Company WarrantsCall Warrants
IssuerSame listed company with that of the underlying sharesAuthorised bank or universal broker
Underlying assetShares issued by the listed companyShares issued by another company, basket of shares or an index
On exerciseNew shares of the company are issued.  Results in dilution of sharesInvolved existing, already-issued shares.  No dilution effect on shares
Expiry dateLonger tenure; usually more than 4 yearsShorter tenure; usually less than 4 years
Settlement methodPhysical delivery of sharesEither physical delivery of shares or cash settlement
  
4."Fully-collateralised" versus "non-collateralised" Call Warrants
 A Call Warrant issue is "fully-collateralised" if the issuer deposits the relevant amount of underlying securities with an independent trustee in order to secure the obligations of the issuer and adequately protect the interests of the warrant holders.
 A Call Warrant issue is "non-collateralised" if the issuer provides for its obligations in a form other than by way of charge over the underlying securities.  The issuer usually adopts dynamic hedging startegies to provide for its obligations under the warrants.
  
5.What are the principal terms in a Call Warrant? 
 
  • Issuer
  • Underlying Asset (e.g. share, a basket of shares, or an index)
  • Warrant Type (i.e. Call or Put)
  • Warrant Style (e.g. European or American)
  • Exercise Price (or Strike Price)
  • Expiry Date
  • Entitlement or Conversion Ratio (e.g. 1 warrant entitles to 1 share)
  • Settlement Method (i.e. either physical settled or cash settled) and
  • Warrant Price (from which values for Premium, Gearing, Implied volatility, Delta, etc. are derived)
6.How to realise the value on Call Warrants?
 If you hold a Call Warrant, the value of your warrant should appreciate if the underlying share price has risen, assuming other factors remaining constant.  You can realise the value of the warrant by selling the warrant in the market.  Alternatively, if the warrant is American-style, you can exercise the warrant to buy the shares from the issuer at the exercise price instead of the current market price.  Your gain is the difference between the exercise price and the current share price.  You can realise this gain immediately by selling the shares in the market (the result would be similar to the case when the warrant is cash settled).
 Normally, you would realise more value by selling the warrant, instead of exercising it, if there are still many days remaining before expiry and when there is still "time value".  You would only exercise the warrant if the warrant price is below intrinsic value, or because you want to own the underlying shares for some reasons, e.g. to be entitled the dividend due.
  
7.What are the factors affecting the price of the Call Warrant?
 
  • Underlying asset price
  • Exercise price
  • Volatility of the underlying asset price
  • Time to expiry of the warrants
  • Interim interest rates
  • Dividend yield of the underlying asset
  • Credit worthiness of the issuer
  • Supply-demand factor on the warrants
8.How do corporate exercise / actions affect the Call Warrants? 
 Call Warrants are subject to adjustments to take inot account any corporate actions arising from the underlying stock, or component stocks in the basket.  Corporate actions such as rights issue, bonue issue, share splits or consolidation may lead to a diluting or concentrative effect on the theoretical value of the underlying stock or basket.  This may result in adjustments to the entitlement, the exercise price or other variables of the Call Warrant.
 For index Call Warrants, adjustments are normally not required on the warrant terms for corporate actions related to the component stocks in the index.  This is because the underlying index will have already adjusted itself to take into account such corporate actions.
  
9.Beware of "time decay"!
 Unlike shares, warrants have an expiry date and therefore a limited life.  As time passes, the time value of a warrant decreases and eventually reaches zero when the warrant expires (except in the case of zero-strike call warrants).  This is known as "time decay".  Thai is, it costs money each day to hold the warrant and do nothing with it.  It is important that you monitor the warrant’s expiry date and performance.  Warrants are intended more for trading purposes.
 A warrant may expire before your expectations are realised, making it worthless.  Therefore it is essential that you select a warrant that has sufficient time to expiry to match your market expectations.
  
  
 

IMPORTANT NOTICE :

The above information should not be constued as an offer, invitation, recommendation or solicitation to subscribe for the CW.  For further details on the OSK Big 20 CW offering, you are advised to refer to the Prospectus dated 16 November 2005 issued in conjunction with the ofering, which has been registered with the Scurities Commission.  A copy of the Prospectus with accompanying Application Forms can be obtained from the offices of OSK Investment Bank Berhad, participating organisations of Bursa malaysia Securities Berhad, members of the Association of Banks in Malaysia, members of the Association of Merchant Banks in Malaysia, and Malaysian Issuing House Sdn Bhd.  Applications for the CW must be made by way of the Application Forms issued together with the Prospectus, or by way of Electronic Warrant Applications through Automated Teller Machines of participating financial institutions.

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