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!

Google Listed In Malaysia

When anyone looks at the post title, they must be wondering if there is a typo error....in fact, make no mistake, it is indeed the famous America-based World No 1 Internet Search Engine powerhouse, Google Inc. The listing in Malaysia Kuala Lumpur Stock Exchange represents a Call Warrant, issued by OSK Investment Bank.

Google's previous day's share price closed at around USD670, which makes up almost USD210billion in market capitalization, which is even larger than the total market capitalization of some less developed countries. Considering its IPO price of USD85 in August 2004, the stock has achieved skyrocketing gain in slightly more than 3 years! Google derives its revenue almost entirely from advertisements linked to its Internet search engine although it is diversifying its sources of sales. For instance, Google has started to sell advertisements in video clips on YouTube, a website it acquired for US$1.65bil last year. Other notable acquisitions include Feedburner and Blogger.com, a popular free weblog system.

Coming back to the Call Warrants listed in Malaysia today, its share price shot up a staggering 140% from RM0.11 (USD0.03) to RM0.265 (USD0.08) with intra-day high at RM0.33(USD0.1) ! More than 6million shares changed hands, hence making it among the Top 5 most active stocks for the day! Now comes the interesting part...The warrants have a conversion ratio of 3,000 to 1, with an exercise price of US$680. This means an investor will need 3,000 Google call warrants plus US$680 – or a total of US$913 – for one ordinary Google share, which is currently trading at less than US$670. This suggests a premium of about 36%, which makes the call warrant very expensive indeed! I wonder if investors chasing these stocks are aware of such conversion terms! Based on my experience, chances are these investors (likely to be retail investors) are not aware of such terms when they bought the shares!

Wall Street, Recession and Inflation

These days watching Wall Street is like riding a roller coaster ride....you never know what is going to happen next! As expected, the subprime issue and financial credit issues continue to plug the Wall and the Street in America, forcing many investment bankers to downgrade their earnings or even incur or write off significant losses. Yesterday was another occasion where Wall Street tumbled 2.6% (or 360 points)! Sentiment has not been helped by skyrocketing crude oil price... it is really a matter of time crude oil will hit USD100 / barrel!

Inflation surely is inching up, like it or not, but to what extent is the question. In some countries where certain controlled items such as petrol price are subsidized, perhaps the higher costs will not be passed down to consumers but there is also a question of how much longer can this last? It is certainly a huge burden for Government to continue with the excess baggage and this certainly does not augur well for the overall balance and free will of trade.

On the other hand, question will be asked if the current US credit woes will lead to a bigger and wider issue, that is, a possible economic slump and recession? Occurrence of this scenario will surely inject shivers in the spine of the rest of the world, given that a good portion of the global exports are absorbed by US.

That being said, the Asia growth story led by both China and India will likely extend a buffer to the sustainability of global economic growth. Besides, latest data posted by US Government in the form of better than expected worker productivity growth rate for the third quarter suggests that growth in US is encouraging and putting inflation in-check. So it is not doom and gloom all the way at the moment. Also, US Federal Reserve seems determined to rescue the economy, given the recent measures to cut interest rates by as much as 75 basis point.

Alibaba, Open Sesame!

Just like the novel, Alibaba.com's opening day listing of its IPO shares happens today reminiscent of a magical bang, despite the previous day's whopping 5% collapse in Hong Kong stock market! Its share price opened more than twice the IPO offer price of HK$13.50 and closed with a price gain of about 80%! For the record, the IPO was oversubscribed 150 times, indicating the frenzy of investors chasing after the world's second largest internet offering after Google in 2004. For those who were fortunate to be awarded the shares from IPO, it is indeed like a strike of lottery!

Let's look at the statistics again....effectively at the IPO price, Alibaba was trading at 106 times its 2007 earnings....much more than any of its peers such as Google (about 46 times) and eBay (about 23 times). Does Alibaba deserve such a loftily high valuation? Definitely not! How about double that with current price? I'm afraid the BUBBLE has just gone bigger!

Calling For "Order" On Hedge Funds

A hedge fund is an investment fund similar to mutual fund where there are a pool of funds invested in a collective manner. Hedge Fund is often structured to avoid direct regulation and charges a performance fee based on the increase of the value of the fund's assets. In the pursuit of maximum returns in today's competitive world, hedge funds has become very popular with estimation of about USD1 trillion in motion. As a hedge fund is largely unregulated, its investment manager is able to deploy a wide range of investment strategies and tactics than it could for a regulated fund, and is therefore considered to carry more risk. They often uses complex investment strategies such as short selling, futures, swaps and other derivative contracts and leverage. They will often seek to generate returns that are not closely correlated to those of the broader financial markets by hedging its investments against adverse moves in those markets.

For the purposes of consumer protection, in most countries hedge funds are prohibited from marketing to investors who are not professional investors or high net worth individuals. They therefore tend to operate in secrecy and is not required to report what they're doing. This is in fact an area of biggest concern.

Today's financial markets are filled with plenty of liquidity, despite the current US sub-prime issues that have threaten to derail global liquidity and credits. Yen carry trades have become a popular cheap source of funds, given Japan's low interest rates and stagnant or deflationary economy. Hedge fund is definitely one the major beneficiary of this source of funds to finance their investment activities. In the pursuit of greater financial returns, it is no coincidence that many of global asset classes have been driven up the roof. This includes real estate property, commodities such as palm oil and crude oil which are trading at record highs respectively! We have already seen the bubble of US housing real estate has finally burst as a result of overzealous speculation! So the big question is will others ultimately suffer the same fate as US housing? This could well happen given the following scenarios:
- US sub-prime issue continues to deteriorate to the extent of causing a collapse of consumer confidence and worst of all a US recession;
- unwinding of Yen carry trades as a result of stronger Yen or rising interest rates due to better than expected Japan's economy and/or higher inflation;
- Bubbles in emerging market's economy particularly China and to a lesser extent India. A great course of concern here is China's overheated stock market and next in line could be Hong Kong due to large inflow of money from mainland China.

Certainly, the above events may not happen as yet but there is always a possibility it may happen one day. So the big question is can something be done to regulate Hedge Funds so that further speculative damages can be prevented? Else, investors will just have to enjoy the party while it lasts!