Occasionally, the Hong Kong stock market can be very volatile. Can I use warrants listed in Singapore to get into the action? And what factors should I consider when buying such warrants?
Singaporean investors can get exposure to the Hong Kong stock market through warrants listed on the SGX that are linked to the major stock market index in Hong Kong, the Hang Seng Index (HSI). Interested investors can simply buy and sell these warrants through their Singapore broker on the SGX.
Using an example of a call warrant, generally it will tend to increase in value when the HSI increases and decreases in value when the HSI falls. The details of the warrant are as follows:
Underlying: Hang Seng Index futures contract
Strike level: 19,400
Expiry date: 01 Jan 2007
Entitlement: 200:1
The way that the warrant works is that it gives the holder the right to buy the HSI futures contract at the strike price of 19,400 on the expiry date of the warrant, being 1 Jan 2007. The other important piece of information you will need is the entitlement of the warrant (also called the conversion ratio). In this example the entitlement is 200:1, meaning you will need 200 warrants to exercise for one futures contract at expiry.
Let’s assume the HSI futures contract is 20,000 at expiry. To calculate expiry value you subtract the futures level (20,000) from the strike level of 19,400 giving you what is called intrinsic value of 600 points. As the warrant has an entitlement of 200:1 you will then need to divide by 200, giving you a ‘per warrant’ value of HKD$3.00. Assuming the HKD/SGD exchange rate is about 5.0 times, you will need to divide HKD$3.00 by 5 to get an expiry settlement of SGD$0.60 per warrant.
Other than the usual selection criteria, the above example highlighted an important point, as the warrant is over a foreign listed underlying asset, it is denominated in a foreign currency ie. Hong Kong Dollars. The warrant however is denominated in Singapore Dollars. Therefore investors need to be aware that changes in the HKD/SGD exchange rate will affect the value of the warrant. This exchange rate can change daily.
Estimating the settlement value at expiry for various levels in the underlying index is an important process, as it gives you reference points which will help you to make decisions on when to buy and sell. For example, if you estimate what the value of the warrant will be if the HSI is at 19,800, 20,000 and 20,200 at expiry, it can help you to estimate your potential profit or loss at expiry. Remembering that if the HSI is at or below the strike of 19,400 the warrant will be worthless at expiry.