What You Need To Know About Warrants Trading?

Warrant is an excellent leverage against the underlying shares (also known as mother share) or securities of a listed entity. It is a tool commonly used by listed companies to raise funds in the market. A "Call" Warrant gives the holder the right, but not the obligation, to purchase (or own) a certain quantity of the underlying shares at a predetermined price on or before a specific date. On the other hand, a "Put" warrant (not available in Malaysia) grants the holder the right to sell the underlying shares at a predetermined price on or before a specific date.

Warrant appeals to investors (particularly retail) because it's much cheaper to own one compared to its underlying shares. The difference between the underlying shares and the warrant is often determined by the pre-determined exercise price (or strike price). The warrant is "in-the money" if the underlying share price is higher than the exercise price, which also means investors who bought the warrant now and decide to convert will make profit, assuming the underlying share price stays constant or higher after conversion. Conversely, if the underlying share price is lower than the exercise price, the warrant is said to be "out-of money", which simply means investors will lose money after converting the warrant to shares. Retail investors often misunderstood the difference between company-issued warrants vs structured warrants.

By virtue of warrant being cheaper than the underlying shares, many retail investors have opted to buy warrants instead of the underlying shares, with the understanding that they can buy more units and make larger gains, without actually understanding the underlying terms and conditions! This is a common pitfall... First of all, warrants are highly volatile, as the percentage gain o loss is higher compared to the percentage change in the underlying shares. Say for example warrant X is trading at $1 and has an exercise price of $2, while the mother share X is trading at $3. A drop in price for Share X by 10% could potentially lead to a fall of 30% for the price of the warrant X! Of course, the reverse situation applies if the underlying share price gains by 10%! Secondly, all warrants carry an expiry date, which makes the warrant worthless if they are not exercised before the expiry date! The period to expiry also refers to the "Time Decay"....the closer to the expiry, the quicker the time decay. An investor therefore needs to understand and monitor the time decay closely so that the investment will not become suddenly "vaporised"! Thirdly, the exercise price of the warrant will determine whether an investor is paying for the "premium" or too much money, in simple terms. It's important to take note that the "premium" factor of a warrant tends to deteriorate as the time to expiry is getting closer. Quite often, you may experience a warrant being "out-of-money" if the time to expiry is less than 6 months, as investors turn risk-averse. Fourthly, a warrant holder does not carry voting rights and is also not entitled to any dividend distribution.

Warrants tend to be short-term trading in nature, unless an investor wishes to convert to the underlying shares for reasons such as voting rights, dividend payment or other special distribution, etc.

There are also differences between company-issued warrant and third party issued warrants. I shall cover this in my next post.

So before you step out and buy warrants just because they are cheaper, think again and please do some homework!