How do I trade put warrants? Can you illustrate some trading strategies?
Put warrants allow investors to earn a profit when the underlying share price falls. Unlike call warrants that move in the same direction as the underlying share price, put warrants actually increase in value as the underlying share price falls and decrease in value as the underlying share price rises.
A put warrant works by giving the holder the right (but not the obligation) to sell the underlying share / index for a fixed price (the exercise price) up to a specific future date (the expiry date). Hence, their value will tend to move in the opposite direction to the underlying share price / index performance.
For example, if you buy a put warrant with a $5.00 exercise price while the underlying shares are at $5.50. This means you have the right to sell the shares at $5.00 on the expiry date. Say the market price of these warrants is currently $0.25, you think that the shares are looking weak and want to profit from your view so you buy the warrants at $0.25. Two weeks later the share price has taken a large fall and the shares are now trading at $4.50, you still have the right to sell the shares at $5.00 at expiry but the value of your right has increased significantly so the put warrants are now trading at $0.75. You now have the choice of either selling your warrants for a $0.50 profit (ie. the current market price of $0.75 less your purchase price of $0.25) or you can hold on to the warrant in the expectation of further gains.
Put warrants can be used by investors who have a negative view on a stock price and want to profit from their view, this is called “directional trading”. Another use for put warrants is as insurance against losses for an existing holding, called “hedging”. Say you have a large holding in a particular share and were concerned that the share price may fall in the short term but do not want to sell your holding. You can puchase put warrants to protect your position against a potential fall. If the share price does fall the put warrant will increase in value, the profit you make on your put warrant holding will partially offset (depnding on how man put warrants you buy) the losses you sustain on your stock holding.
So, in a nutshell, traders who think that the price of the underlying share is heading south will tend to use put warrants. Generally, traders or investors with this view are known as ‘bears’. Another common method of trading the downside is to short call warrants (ie. Sell call warrant that you do not already hold), this has two disadvantages. Firstly, you are not allowed to hold short warrant positions overnight (unless you want to be subjected to a forced buy-in by the SGX) and hence these trades can only be used intra-day. Secondly, when you short a warrant your maximum loss is unlimited as the warrant prices can keep rising against you, whereas with a put warrant your maximum loss is limited to your initial capital.
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