Macquarie has a range of call warrants over blue chip stocks that expire in 2011 and 2012. The following warrants have exercise prices close to their respective last traded underlying share prices:
CapitaLand: CapitalaMBLeCW120103 (JA7W) exercise price $4.10.*
Cosco: CoscoCorpMBLeCW120103 (JA4W) exercise price $1.30.*
DBS: DBS MBL ECW120103 (JA6W) exercise price $13.80.*
DBS: DBS MBL eCW111003 (IL6W) exercise price $15.50.*
SGX: SGX MBL eCW110901 (IL4W) exercise price $9.00.*
SingTel: SingTelMBLeCW110404 (HJ5W) exercise $2.90.*
UOB: UOB MBL ECW120103 (JA8W) exercise price $17.80.*
Warrants are not just for the short term investor seeking a leveraged exposure to underlying shares at a fraction of the price. Longer term investors who hold on to their positions for a month or more can also find warrants suited to their profile.
Why buy long dated warrants instead of buying shares or margin instruments?
With long dated warrants, you pay only a fraction of the share price up front and get exposure to the capital movements in the underlying share over the life of the warrant. Your losses are limited to your investment capital, and you will not face margin calls or forced selling.
Warrants are geared instruments, giving you an increased exposure to shares for a smaller outlay. Thus they tend to move in greater percentages than the underlying shares. So warrants allow you to potentially earn a greater percentage return from a share price movement than you might achieve by owning the share itself.
It is important to remember gearing works in both directions, so a fall in the share price would also cause a greater percentage fall in the value of the warrant
Lower time decay for longer dated warrants
One of the concerns of longer term investors is the time decay of warrants. The shorter dated a warrant, the higher the rate of decay.
Hence longer term investors should actually look for warrants that have a lifespan of 1 to 2 years, as the rate of time decay is much less than the shorter dated warrants.
In the hypothetical example below, the investor intends to hold on to his DBS warrant position for 6 months. Both the long dated and shorter dated call warrants have the same exercise price. The longer dated warrant expires in 2 years or 24 months, while the shorter dated warrant expires in just 8 months.
After 6 months if DBS’ share price remains unchanged at $14.50, the long dated call warrant will fall by approximately 8% due to time decay. However, all it takes is a 10% increase in the share price, and the long dated call warrant will increase by roughly 20%. This is the gearing effect associated with warrants, where a smaller percentage increase in the underlying shares gives a larger percentage increase in the associated call warrant.
Looking at the shorter dated call warrant, if DBS’ share price remains unchanged after 6 months, the shorter dated call warrant will fall by more than 60% due to the higher rate of time decay. It would take a 20% increase in the share price to see the gearing effect kick in to the warrant price.
Thus if you want to take a long term view on a share price for a fraction of the outlay and wish to reduce the effects of time decay while enjoying the gearing effect associated with warrants, you may wish to consider warrants with a longer expiry date.
Table 1: Holding long dated and shorter dated warrants for 6 months
| |
DBS share price |
Long dated call warrant |
Shorter dated call warrant |
| Price |
$14.50 |
$0.19 |
$0.10 |
| Exercise Price |
|
$16.30 |
$16.30 |
| Warrant Term |
|
24 months |
8 months |
| 0% share price increase |
$14.50 |
-8% |
-61% |
| 10% share price increase |
$15.95 |
20% |
-21% |
| 20% share price increase |
$17.40 |
51% |
36% |
| 30% share price increase |
$18.85 |
85% |
107% |
* Price change estimates above are indicative and assume no change to other variables such as dividends, interest rates and implied volatility.
* Share and warrant price increases above are after 6 months.
Longer dated warrants – a more conservative choice
The effective gearing of a warrant estimates the amount a warrant price will move for a corresponding share price move. Thus a warrant with an effective gearing of 5X means for a 1% movement in the underlying share price, the warrant should move approximately 5%.
Longer dated warrants tend to have lower effective gearing compared to shorter dated warrants. Thus they tend to be more suited for longer term investors who may not have an aggressive or high risk profile.
How do I tell a long dated warrant from the name?
The name of a warrant contains the expiry date of the warrant. The warrant name can be deciphered as follows:
Eg. DBS MBL eCW111003
DBS: The underlying share is DBS. The warrant name always starts with the name of the underlying share or index.
MBL: Macquarie Bank Limited. This is the name of the issuer of the warrant.
eCW: European style call warrant. All warrants in Singapore are European style, which means they can only be exercised at expiry. It is more important to pay attention to the “CW” which means call warrant. “ePW” would indicate it is a European style put warrant.
111003: This is the expiry date of the warrant, read from left to right as the year, month and date. Thus the year is 11 (or 2011), the month is 10 (or October), and the day is 03. Thus 111003 implies the warrant expires on 3rd October 2011.
If the warrant name ended with “eCW120103”, then this is a call warrant which expires on 3rd January 2012.
Is it true that short dated warrants tend to have more liquidity?
Short dated warrants tend to have more turnover, but not necessarily more liquidity. n the absence of other market participants, issuers provide the liquidity (best bid / offer volume) for the warrants.
Hence, the liquidity of the warrant is more closely related to the liquidity in the underlying stock and the quality if the market maker. Having a look at the volume on the best bid/offer for a warrant will generally give you a better indication of the liquidity.
In fact warrants with high turnover can often be subject to higher price volatility due to the effects of supply and demand on the warrant price.