A warrant is a form of financial derivative that entitles the holder to buy/sell shares of the company that issued it at a specified price. The warrant purchased will expire after a certain amount of time, rendering it worthless unless converted into the mother share. Investment guru Warren Buffett argued that derivatives are “financial weapons of mass destruction” as they pose a dangerous incentive for false accounting. He also described them as “easy to enter and almost impossible to exit”.

NATURE OF WARRANTS

Warrants are either issued on their own or along with a rights issue by the issuing company. They come in the form of either a Call warrant or a Put warrant. Call warrants give you the right to buy the underlying securities whereas Put warrants give you the right to sell the underlying securities. The exercise price refers to the price which you can purchase the mother share before expiry of the warrant.

The conversion ratio shows the number of shares you can purchase for every warrant. Investors should take note of the expiry date of the warrant as the longer the period before its expiry date, the more volatile/cheaper the warrant may be priced at. Below is an example of a warrant from page 265 of issue 334 of Shares Investment (Singapore).

The warrant premium measures the extra cost incurred by buying a warrant and exercising the warrant into the shares, over simply buying the shares directly in the market.

From the example, the premium of COSCO warrant at 10.78 indicates that the warrant is trading at a premium above the market price of the underlying investment. The higher the premium, the higher the price of the warrant. Although a warrant usually trades at a premium, the size of the premium declines as its price climbs and as it approaches expiration.

A warrant’s ‘gearing’ is the way to ascertain how much more exposure you have to the underlying shares using the warrant as compared to the exposure you would have if you buy shares through the market.

Thus, the gearing of COSCO warrant at 5.302x indicates the volatility of the warrant price in relation to its share price. The higher the gearing figure means that the warrant tends to move up and down in greater percentages than its underlying share.

MORE FOR EXPERIENCED TRADERS

To learn the true mastery on warrants requires hindsight instead of just pure luck. Warrants require little investment as compared to buying the mother share but fluctuate more violently, making them very risky. This is the reason why warrants are mostly played on the market by veteran traders rather than retail investors. Retail investors may not possess the acumen to jump ship when the going gets tough, preferring to stick with their warrants till the end, most of the time resulting in heavier losses or end up bankrupt overnight. Therefore, we advise readers to be more prudent when investing into warrants.