A structured warrant is a financial instrument issued by third-party financial institutions, usually banks. Structured warrants offer investors an alternative avenue to participate in the price performance of an underlying asset at a fraction of the underlying asset price. How does structured warrant differ from company issued warrant? Ordinary warrants (sometimes referred to as company issued warrants) are issued by the underlying companies themselves, often in conjunction with a fund raising exercise. For instance, Gunung issues a warrant Gunung-WB on its shares at a strike price of RM0.50 which has maturity date of 2/10/2020. As the warrants get exercised, they will be converted into new shares resulting in an increase in the company’s shares.
As opposed to company issued warrant, structured warrant is not related to the company’s share in the sense that it is not issued by the listed company. The exercise of the structured warrants will not have an effect on the number of shares in the underlying company. However, the price movement could be linked to the price movement of the underlying share. Bear in mind that when purchasing structured warrant, you are dealing with the financial institution that issued the structured warrant, and not the company itself.
A structure warrant could also be issued based on an index. For example, available in Bursa are index warrants based on FTSE Bursa Malaysia KLCI (FBMKLCI, 富时大马指数), and Hong Kong Hang Seng Index (HSI, 恒生指数). There are 2 kinds of index warrants listed in Bursa Malaysia – call warrants and put warrants. To put in simply, if you feel bullish on the market, you can look into the call warrants, and if you feel bearish on the market, you can look into the put warrants.
Below are benefits of structured warrant:
A warrant is usually priced at a fraction of the underlying share price. This allows you to trade more warrants than the underlying shares for the same investment outlay.Trading warrants therefore, offer benefits of leverage or gearing in varying degrees. For instance, a small percentage gain in the underlying share price may lead to a larger percentage gain in the value of a call warrant
2) Unlimited upside but limited downside
The maximum potential loss to you is limited to the warrant price, which is usually a fraction of the share price. The potential gain of a warrant may be unlimited as it depends on the movements of the underlying share.
3) Protects the value of your asset
A “put warrant” allows you to hedge against a fall in the price of a stock in your portfolio. You are, therefore, assured of a minimum value equivalent to the exercise price for the stock in your portfolio. This is very true in a bearish market – just look at how FBMKLCI-HB had performed during the period of correction between Nov 2014 to Jan 2015 you will see a whopping 174% gain over this period!
4) Diverse market access
If you ware purchasing into index and basket warrants, that gives you exposure to a sector or market, as their value are linked to the performance of a benchmark index and pre-defined basket of shares respectively.This eliminates the need of trading into a basket of individual stocks to have the same access. For instance, by buying into HSI call warrants, you are tracking against the Hang Seng Index and this give you the exposure and access to the basket of shares in Hang Seng index itself, with minimum investment.
Risks involved with structured warrant are:
1) Warrants have lifespan
Warrants have an expiry date, so it is essential that you select a warrant that has sufficient time to expiry to match your market expectations. Upon expiry, there is no value to the warrant. As a matter of fact, the closer to expiry, the lesser the value it is.
2) Magnified gain and loss
Leverage is a “double-edged” sword. In addition to magnifying gains, warrants can also magnify losses when the value of the underlying asset moves against the warrant position. For instance, a fall in the price of the underlying share can lead to a larger percentage loss in the value of the call warrant.
3) Credit risk
Though unlikely to happen in Malaysian’s issuer, there is a risk that the warrant issuer will not be able to fulfill its obligations during the exercise of the warrants.
4) Liquidity risk
Liquidity risk occurs when a warrant holder is unable to sell his warrants for a reasonable price in the market.This is due to insufficient buy orders, which affects the market price of the warrants.
5) Extraordinary circumstances
The warrant issuer may declare a lapse of the warrant or bring forward the expiry date. This occurs when a circumstance listed in the terms and conditions of the warrants issue arises, such as the delisting of the underlying asset.
In conclusion, structured warrant provide an opportunity to leverage on the market movement of the underlying share through gearing effect. Investment in warrant is sometimes of higher risk if extra caution is not been exercise on the market condition and the movement of the underlying stock. Also, one should understand very clearly the attributes such as maturity date, exercise price, gearing ratio before buying into them.