Warrants are a form of financial derivatives. Derivatives’ values are dependent on and derived from underlying assets. For e.g., for a warrant which tracks ABC company as the underlying asset, its value is dependent on ABC company’s share price (Note: there are other factors that affect the price of a warrant).
The definition of a warrant – a warrant gives you the right but not the obligation to buy the shares of an underlying asset at the exercise price and at a future fixed date. (note: some warrants are settled in cash and no conversion to shares are involved)
Warrants, unlike shares, have an expiry date, and become worthless thereafter. They are either settled in cash or be converted to shares of the underlying.
As they are derivatives, many people tend to associate them with speculation rather than as an investment – as seen in Larry Laverkamp’s (Dr Money) article, “Investing vs Gambling“.
Different Types of Warrants
There are many types of warrants available. The warrant market in Australia is more matured, they have warrant types like instalments, barrier warrants, endowments, etc. To know the details, you can visit ASX website. But in general, there are 2 main classification – trading-style warrants and investment-style warrants.
Trading-style warrants – They are generally short term, usually having a lifespan of 3-6 months. Thus, it is highly speculative and risky. An investor who opts for this style is usually “…looking for short-term leveraged exposure to the underlying instrument” and “…may have no intention of ever trading the underlying instrument, but may be looking to profit from short term movements in the value of the instrument.” (quoted from ASX website)
Investment-style warrants – Compared to trading warrants, they have a longer lifespan, usually of a few years. They are perceived as having lower risk than trading-style warrants. “…other features of some investment-style warrants, such as an entitlement to dividends, or a capital guarantee on the initial investment.” (quoted from ASX website)
Warrants in Singapore
In Singapore, the warrants are known as “structured warrants” which I suppose, is equivalent to trading-style warrants based on their similar characteristics (correct me if I am wrong). Structured warrants usually have a lifespan of 3-6 months and are issued by third party institutions like banks. Right now, they are “cash settled” which means all profits or losses are delivered or paid in cash between the issuer and investor, and there is no conversion to shares being done. It is also important to note that all SGX traded warrants are European style, which means that a warrant cannot be exercised (cash settled) before the expiry date. An investor can only sell it to another investor during the period. You can trade warrants like shares in SGX and their fees and charges are the same too.
As warrant trading has become more popular, Macquarie Bank had announced the issuance of investment warrants in Singapore from 9th Jan 08 onwards. From their press release:
“Investment Warrants allow investors to buy shares in two payments – one now for a fraction of the share price, and one in the future.” One big advantage over the structured warrants – “…investors are entitled to payments equivalent to 100 per cent of the ordinary dividends”.
Why invest in warrants?
Leverage – Like many other derivatives, warrants have the advantage of leverage over traditional investment vehicles. For a small amount of capital, you can get a much larger exposure than you can from buying the shares directly.
Hedging – Investors may want to hedge against price falls in the stocks that they hold. Thus, they can purchase a put warrant on the underlying stock, where a decrease in price of the underlying will lead to an increase in price of the put warrant. The investors would be able to use the gains from the warrant to offset the losses from their stocks.
Warrants and Options – What is the Difference?
Warrants are very similar to options except for one major difference. Warrants are issued by third party institutions (structured warrants) or by companies (company warrants) as opposed to options, where they are issued by investors holding the shares.