Structured warrants back in vogue, worth a closer look - October 20, 2011

http://www.businesstimes.com.sg/sub/companies/story/0,4574,461208,00...

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Hock Lock Siew

Published October 20, 2011

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Structured warrants back in vogue, worth a closer look

By R SIVANITHY

ST Index (Real-time) past couple of months. Yesterday, for example, saw no less than five of 2,694.01 26.20 them in the top 20 most active list, suggesting such instruments are making a comeback after about two years in the doldrums - not a surprise Thu, Oct 20, 2011, 17:58
KLCI HSI 1,441.18 17,983.10 -9.07 -326.12 -90.39

STRUCTURED warrants (SWs) have been in the trading limelight for the

given that SWs are popular when volatility is high and markets are range-bound as they are now. It might therefore be worthwhile for punters to review some warrant basics.

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For better organised information, it is better to visit the respective issuers' websites for details of prospective SWs. Since Macquarie's SWs dominate the present warrant landscape - all six in the top 20 active list yesterday were issued by Macquarie - we'll stick to its SWs for illustration. Basically, SWs offer short-term traders a leveraged play on an underlying asset such as an index or a stock. When that asset moves in the desired direction, the warrant holder should enjoy the leverage benefits, meaning magnified profits. Two types of SWs are available. Calls give the right to buy the underlying asset at a fixed exercise price and rise when the underlying rises. Puts give the right to sell the underlying asset at a fixed exercise price and rise when the underlying falls. In the case of yesterday's most actively traded counter, which, using SGX's cumbersome nomenclature, is labelled 'HSI18400MBeCW111129' the underlying asset is the Hang Seng Index (HSI). MBeCW denotes that it is a Macquarie Bank equity call warrant and the numbers 111129 denote the expiry date, which is 29 Nov 2011. The relevant URL is http://www.warrants.com.sg/en/warrants/indicator_e.cgi?code=O5MW. First, note the figure 18,400, which denotes the exercise price and represents the HSI level around which the punter is betting. Since the call gives the holder the right to buy at 18,400, the warrant is said to be 'in-the-money' if the HSI rises above 18,400. The HSI yesterday closed at 18,309, meaning the warrant was 91 points or about 0.5 per cent 'out-ofthe-money' (OTM). This is shown in the Macquarie website under the heading 'Moneyness'. Second, note that the exercise price of 18,400 is in HK dollars while the warrant is traded in Sing dollars so currency conversion is needed. Since one thousand warrants are needed to convert into one HSI, this means at yesterday's closing price of 16.5 cents per warrant, a holder who wishes to buy one HSI will need $165 or about HK$1,017. Although no payment or conversion is actually done, in theory if a holder was to fork out the HK$1,017 and the HK$18,400 to buy one HSI, he would be paying a total of HK$19,417 to buy something worth HK$18,309.

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Structured warrants back in vogue, worth a closer look - October 20, 2011

http://www.businesstimes.com.sg/sub/companies/story/0,4574,461208,00...

The premium is therefore HK$1,108 or just over six per cent and this is given in Macquarie's website under 'Premium'.
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Third, note the leverage or gearing benefit. Anyone holding $165 or HK$1,017 worth of warrants can benefit from rises in an asset valued at HK$18,309, so the simple gearing is 18309/1017 or 18 times. However, it is more accurate to moderate this figure by the warrant's delta, which measures movements in the warrant's price to a one dollar move in the underlying's price. In this case, Macquarie has calculated this warrant's delta as 0.5, so the correct gearing of this instrument is 18x0.5 or about 9 times which is shown in the website under 'effective gearing'. This means that on average, a one per cent rise in the HSI will translate to a nine per cent rise in this warrant. This, perhaps more than anything else, accounts for the recent upsurge in warrant trading, especially since the HSI can swing up to five per cent every day. The above is, of course, a highly simplified treatment of a relatively complex and risky instrument. Punters should familiarise themselves with other important parameters like volatility and time to maturity before taking the plunge. But given the current spike in volatility, it could well be worthwhile to do so.

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