| Naga Wisdom 1 |
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What is a Warrant?
A warrant is an option contract between a buyer and a seller. You, as the buyer, purchase the right, but not the obligation, to buy the underlying asset (for call warrant) at a specified price - namely the exercise price or strike price.
This right has a limited lifespan and it ends when the warrant reaches its expiry date. In order to secure the right, you pay a premium, which is also known as warrant price. The time in which you can exercise the right attached to the warrant depends on the exercise style of the warrant i.e. American or European exercise style.
By exercising this right, you can buy the underlying asset at the exercise price from the warrant seller (known as issuer) and the warrant seller has the obligation to deliver or accept delivery of the shares at the exercise price.
Warrants listed on Bursa Malaysia are tradable securities, just like buying and selling shares. A warrant derives its value from an underlying asset such as a blue chip share, a basket of shares or index.
There are two types of warrants: |
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Company Warrants
A company warrant is issued by a company over its own shares to raise capital. Each warrant's value is dependent on the value of the company's share. |
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Structured Warrants
This is the type of warrant that allows you to buy a specific amount of equity, index or other underlying asset from the issuer, usually an investment bank, at a specific price and within a certain timeframe. The issuer does not issue warrants to raise funding but provides you with an investment tool to manage your investment portfolio.
The main differences between company warrants and structured warrants are: |
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Company Warrants |
Structured Warrants |
| Issuer |
Own company |
3rd party issuer, usually a reputable investment bank |
| Underlying |
Own company shares |
Any underlying asset that meets legal / regulatory requirements |
| Exercise Style |
American |
Usually American or European |
| Dilution |
New shares issued; usually results in share dilution |
No new shares issued; no dilution of shares |
| Expiry Period |
Usually 3 - 5 years |
Usually 6 months - 2 years |
| Liquidity |
No market maker |
Designated market maker to ensure liquidity |
| Settlement period |
Physical delivery of shares |
Usually cash settled |
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What is a Call Warrant?
A call warrant gives you the right, but not the obligation, to purchase a certain amount of the underlying asset at a predetermined exercise price within a predetermined time.
A call warrant follows the trend of its underlying asset. You would want to buy a call warrant when you believe that the price of the underlying asset will rise and you would want to benefit from that upward price movement.
Diagram 1 below illustrates the payoff of a call warrant when exercised or at expiration. A call warrant has unlimited upside similar to buying the underlying asset, but the loss is limited to the amount initially invested in the call warrant. When the underlying asset price exceeds the exercise price, the price of the warrant will start to rise and you can realise the gain by selling the call warrant in the exchange (theoretical warrant prices can be estimated using the NagaWarrants Calculator).
To understand which course of action would put you in a better position, i.e. a) sell the warrant in the exchange, b) exercise the warrant or c) hold the warrant until expiry, see Naga Wisdom 5.
Diagram 1: Payoff of a Call Warrant |
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American and European Warrants
There are two common exercise styles of warrants, American and European. The difference between the two is that an American style warrant can be exercised at any time up to the expiry date of the warrant.
Since a European warrant can only be exercised on the expiry date of the warrant, given everything else being the same, it is less expensive than an American style warrant. In other words, an American style warrant is more expensive because you are paying for the right to exercise the warrant at any time during the lifespan of the warrant.
Exercise Price (Strike Price)
The exercise price is the price at which you can buy call warrant.It is determined by the issuer at issuance and remains the same throughout life of the warrant*. The exercise price is the benchmark for you to determine whether your warrant is Out-of-the-Money (OTM), In-the-Money (ITM) or At-the-Money (ATM).
* Unless adjusted due to occurrence of certain events.
Moneyness
Call Warrant
In-the-Money (ITM) - when the underlying asset price is above the warrant exercise price (Underlying price > Exercise price).
Out-of-the-Money (OTM) - when the underlying asset price is below the warrant exercise price (Underlying price < Exercise price).
At-the-Money (ATM) - when the underlying asset price equals the warrant exercise price (Underlying price = Exercise price).
Referring to the Diagram 2 below, when ABC's share price is at RM2.50, higher than the exercise price of the warrant at RM2.11, the call warrant is ITM (Scenario A).
In Scenario B, the call warrant is OTM when ABC's share falls to RM2.00, which is below the exercise price of RM2.11.
Lastly in Scenario C, when ABC's share and exercise price are the same, the call warrant is ATM.
Break-even price of the warrant is RM2.48 ([RM0.075*5] + RM2.11]). You would want to exercise the warrant above the break-even price. However, in order to make the most gain out of your warrant, you should evaluate which method of warrant settlement gives you the highest gain (See Naga Wisdom 5 : How to Calculate Cash Settlement Amount, for a detailed explanation).
Example |
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Underlying
Scenario A: ITM-Underlying Closing price (A)
Scenario B: OTM-Underlying Closing price (B)
Scenario C: ATM-Underlying Closing price (C)
Exercise price
Exercise ratio
Call warrant price
Expiry period |
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ABC
RM2.50
RM2.00
RM2.11
RM2.11
5 warrants : 1 share
RM0.075
6 months |
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Diagram 2: Payoff of ABC Call Warrant
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Strategies