What is Warrants in Stock market investment?

Anything important thing I need to know about Warrants in Stock market investment?

james Asked on September 29, 2015 in Investment.
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Investing in shares has always been seen as a relatively high risk method due to the volatility of the market as well as the uncertainty of market forces that one could not foresee. Hence, investors have turned to other investment methods which include REITs (Real Estate Investment Trusts), property investment and warrants. Warrants for one, is one of the 5 types of equity derivatives which are commonly traded and this is one of the common investment methods under Bursa Malaysia.

Basically, warrants allow the holder to buy an underlying security at a specific price although they are not under any obligations to do so. Apart from that, they can also decide to buy the units at the quantity that they like as well as the future time as and when they need to. Warranties are issued by the company and unlike stocks, they are not issued by the investor or shareholders. Under most circumstances, warrants are issued by the companies who are looking to provide new-issue offering to attract more investors to a new security product. It is also commonly used by the companies concerned to help increase the confidence in a stock among its shareholders as long as the underlying value increases.

Why invest in Warrants

One of the very attractive factors about warrants is that they are transferable and lower in terms of risk. In fact, warrants are commonly regarded as long-term investment schemes. They are typically favourable investment methods by hedgers and speculators which is well known for its transparency. Apart from that, it is also a good investment tool for individual or smaller investors as the initial investment is quite low while the cost of a warrant is also proportionately lower than the Mother Share.

Basically, if invested correctly and soundly, warrants could be very attractive and profitable methods where you need not have to pay too much initially while having the potential for larger gains. Flexibility in terms of investment is another advantage where you are not confined to only buying the share at a low price and selling them at a higher price. You can also invest in warrants where you can expect the price to fall. This means that it is actually possible to make considerable profit during both the bull and bear market conditions.
On the downside, warrants could also cause huge losses especially among the larger investors who might have bought a lot of warrants. In the worst-case scenario, a warrant could have zero value especially if you fail to sell them after the expiry date.

Types of Warrants

There are a few types of warrants offered in Bursa Malaysia. The most common type of warrant is known as Call Warrants. This is where it is basically the investor is able to decide and determine the number of shares, the price intended as well as the date that they would like to own. Generally, Call Warrants come with a fixed tenure where it would mature over a specific time frame and if it is not exercised then, the specific warrant would be worthless after it expires. This represents the risk that come with Call Warrants because if the price do not increase by the specific term, it would not be worth anything. Therefore, if you are planning to invest in Call Warrants, you must carefully select those that offer sufficient time before the expiry date comes around.

Call Warrants

Call Warrants’ value are derived through the value of the underlying security stock and hence, it differs from trading stocks naturally. This means that the value is not derived through the performance o the company and it is based purely on the attractiveness and perceived profitably of the stock in Bursa Malaysia. The only similarity with stocks is in its trading method where apart from that, the Call Warrant holder does not hold any rights like that of a shareholder. This means that Call Warrant holders cannot vote and will not be accorded with shareholding or dividend rights and consequently, they do not have any voice like shareholders. This subsequently mean that they are basically passive shareholders who will not have a say in any issues of the company (no matter how many Call Warrants you hold) but will be affected by any major decisions or changes within the company.

In Call Warrants, the ‘Mother Share’ is referred to the share which the Call Warrant is based on. The official term for ‘Mother Share’ is known as the ‘Underlying Security’. The expiry date or referred to as the ex-date is perhaps the most important element in Call Warrants and this is the date you must be aware of so that you know when you must redeem the warrant. The Ex-Date is important here because once the Call Warrant Expires, it will cease to exist which means that the value of the call warrant will be paid according to the formula given where if the price is lesser than the exercise price, then you will be left with nothing.

The formula for calculating the cash settlement is:
(Settlement Price – Exercise Price / Entitlement Ratio) x (Number of Call Warrants Exercised – Exercise Expenses)

You must also be aware of the Exercise or Strike Price which refers to the stated price per share where the mother share could be traded by the holder. Settlement Types refer to the method by which the warrant holder settles the Call Warrant when the Ex-Date expires or matures. This could be physical settled or cash-settled up to the discretion of the holder and the Settlement Price is also agreed which is determined by the market.

There are 2 major ways of exercising Call Warrants like the European Warrant where the Call Warrant can only be exercised on the Ex-Date itself. American Warrant exercise is where the Call Warrant could be carried out anytime or on the Ex-Date and is up to the discretion of the holder.

Put Warrants

Another type of warrant available under Bursa Malaysia is Put Warrants. Unlike Call Warrants, Put Warrants’ profits are derived mainly through the falling of a share price instead of banking on it to increase.

For example, a Put Warrant will allow you to sell at a certain price. Say the price that you are looking at is RM10 and the put warrant costs RM0.60. If the share price drops to RM5.00, your put warrant will be worth at least RM5.00 because at this price, you will be able to buy a share of the company for RM5.00 and then sell it again immediately which means you have utilized the warrants for RM10.00. Your profit here is RM5 but if the price increases then you will be suffering a loss. For instance, if the price of the share increases to RM15.00, then it would not worth anything because this is when the investors would be selling them for RM15.00 in the open market while you are holding RM10.00 warrants. Basically, a Put Warrant is a security method in which the holder is given the right to sell the underlying security at a price specified which is widely considered as an uncommon method of investment.

What to consider when investing in Call Warrants

As an investor, every movement in the market will concern you and if you are looking to invest in Call Warrants, you must consider the movement of the Mother Share because it would affect the warrant. If the Mother Share is very volatile, the Call Warrant might follow suit. Call Warrants allow you to foresee how much you will obtain at the end of the Ex-Date where it is determined by the movement of the particular stock.

When buying warrants, you will be given a warrant certificate which will state very clearly all the details and information about the investment. Whether they are Call or Put Warrants, the Expiry Date is stated where as mentioned, you will have to dispose them before or on that date. The certificates will also stipulate their exercise style (American or European) as well as other information like the number of shares and such.

Which warrant should you choose?

There are many warrants available and traded through Bursa Malaysia. Wijaya Group, Hubline, Utopia, Perwaja Steel, DRB-Hicom are some of the companies that offer warrants. So how do you select which warrant to invest in before plunging into the market? You must first understand and learn about the product of the company before buying its warrants. Where this is concerned, the best option is to buy warrants from companies that you know and are performing well. You must also know what the current market is like which will then govern the performance of the specific stock.

If the market is going on a bullish run, then you might want to invest in Call Warrants and Put Warrants if the market is going on a bearish trend. Set a target and this is most important when investing in warrants because you will have to contend with the likes of the expiry date as well as the settlement price which you might want to sell in future. As with all investment tools, ensure that you are not over-investing or having insufficient funds.

sazzy Answered on September 29, 2015.
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