warrants presentation - vunani private clients
TRANSCRIPT
Introduction to Warrants Date - Speaker
Table of Contents
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3
6
8
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12
Advantages and General Terminology
What is a warrant
Call Warrants
Put Warrants
Styles
Types of Warrants
The Mathematics 13
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What is a Warrant / Definition
Defining a Warrant:
A warrant is a geared financial instrument which gives the warrant holder the right but not the obligation to buy, sell or participate in the performance of the underlying security, before or on the expiry date
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What is a Warrant / Gearing / Underlying / Cover Ratio
• Leverage/Gearing To use a financial instrument to gain greater exposure to the potential return on an investment while investing a smaller amount
• Underlying Security
What the warrant is written on. Can be a variety of securities ranging from shares to currencies and commodities
• Cover ratio
The number of warrants one has to purchase to gain exposure to one security = Conversion Ratio/Delta
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What is a Warrant / Strike Price / Expiry Date / Time Value
• Strike Price/Exercise Price The price, initially agreed upon, at which the investor can buy or sell the underlying security
• Expiry Date The last date on which the warrant holder can exercise their rights
• Time Value
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Call Warrants / Definition / Example
Call Warrants Gives the holder the option to purchase an underlying security at an agreed price
Example If an investor believes that the price of Share A will increase they will buy a call warrant that allows them to purchase Share A at the strike price R100. If in future the price rises to R120 the warrants holder can exercise the right to purchase Share A at R100. If we assume a cost of R5, a R5 loss will be realised as long as the price of the underlying is lower than strike price, from R100 –R105, the loss becomes less and R105 is the breakeven price in this example
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Put Warrants / Definition / Example
Put Warrants Gives the holder the option to sell an underlying security at an agreed price
Example If an investor believes that the price of Share A will decrease they will buy a put warrant that allows them to sell Share B at the strike price R90. If in future the price drops to R80 the warrants holder can exercise the right to sell Share B at R90. If we assume a cost of R5, a R5 loss will be realised as long as the price of the underlying is higher than strike price, from R90 –R85, the loss becomes less and R85 is the breakeven price in this example
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Styles / American / European
Styles
American Style The warrant holder may exercise their rights at any time between listing and the expiry date
European Style The warrant may only be exercised on the date of expiration
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Advantages / Bull and Bear profit / Cost saving / Limited Downside
• Advantageous in bull and bear markets Whether you believe the market is going to rise or fall there is a warrant for you
• Reduced Cost The cost of trading in the warrant is generally a lot cheaper than the cost of trading directly in the underlying as you pay fees on the warrant cost and not on the underlying nominal value
• Upside unlimited, downside limited The maximum loss one can make on a warrant investment is the initial price/premium paid to purchase the warrants
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General / Leverage / Market Maker / Limited Life
• Leverage Investors can gain full exposure to the price movement of the underlying securities by investing a smaller amount of capital. For example: If the leverage on the warrant is 6, a 10% increase in the price of the underlying should result in a 60% increase in the value of the warrant
• Market Maker The issuer of the warrant will always buy back warrants should an investor want to end his particular exposure
• Limited Life Warrants have a limited life span and thus the warrant may expire without the holder’s expectations being realised
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General / Rights / Extraordinary Event / Credit Risk
• Limitation of rights Holding a warrant does not give the investor the same rights as holding the underlying share until the warrants are exercised. An example of a right is -voting at annual general meetings
• Extraordinary event In certain circumstances the warrant issuer has the right, to declare an extraordinary event, resulting in expiry of the warrant, prior to the specified expiry date
• Credit Risk Purchasing a warrant from a particular issuer implies that you are taking on the credit risk of that issuer
Different types of warrants Single equity warrants (vanilla warrants) These are call and put warrants. They allow investors to buy (call) or sell (put) an underlying share at a predetermined price on or before a specified date.
Basket warrants Basket warrants are very similar to vanilla warrants except that the underlying asset comprises of shares from a group of different companies. The companies concerned often carry out similar activities e.g. mining or transportation.
Barrier warrants Barrier warrants are similar to vanilla warrants except that they have a barrier level. If the price of the underlying asset breaks this level, the warrant becomes worthless and holds no further rights to the holder of the warrant.
Others are Bond warrants Index warrants Discount warrants Capital protection warrants Currency warrants Commodity warrants
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The Mathematics / Factors / Effect
Pricing and Valuation The price of warrants is dependent on the following factors: • Underlying share price • Time to expiry • Volatility • Interest rates • Dividend expectations
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The Mathematics / Example
• Buying XYZSBE warrants
• Priced at R 1 | Delta 0.5 | Conversion 10:1 • To get exposure to 1000 XYZ shares, Cover Ratio • Conversion/Delta = 20 | Shares x Cover Ratio = 1000 x 20 = 20000 warrants • 20000 warrants @ R 1 = R 20000 • XYZ share price moves from R100 to R110 • XYZSBE moves from R1 to R1.50 (R1*0.05)=warrant moves R0.05 per R1 for
underlying), 0.05 = 1/Cover Ratio • R1.50 x 20000 warrants = R 30000 • End value/Begin Value = 30000/20000 = 50% growth for a 10% move in
underlying
* The above example ignore any transaction costs
