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Wednesday, 11 November 2015

Basic Sharing on Warrants

Call/Put warrants are being traded due to their leveraging concept in nature. Leveraging means they share exactly the same risk with derivatives. FYI, call/put warrants are created by Structured and Derivatives Department. Leveraging means you trade using a fraction of the mother price to control exactly the same market value.

A lot of investor mistakenly thought that low upfront capital means suitable for new investors with limited capital to start with. It is a very wrong concept. Leveraging concept in a nutshell means it MAGNIFIES YOUR WINNINGS AND LOSSES AT THE SAME TIME! It is for professional traders and not newbies.

I would like to touch few financial jargons which you may seldom/may not be using when you are trading warrants. Not to scare you guys but to point out the complexity and technical skill required to trade warrants.

Delta Value:
Delta = Change in warrant price / Change in underlying share price.
Meaning how many % the warrant price change vs the changes of the mother price. You need a higher delta so that when the mother price moves, the warrants will moves in a higher %

Effective Gearing (Very important)
= Gearing X Delta Value
% change of price of warrant vs the change of 1% in the mother price. You need a higher EG to have a meaningful fluctuations of warrant price.

Implied Volatility
It is a probability/estimation of future prices, rather. The higher IV, the probability of warrants futures price moves in tandem with mother price will be correlated. Higher IV, the better.

How to combine and use this few parameters?
1st Choose the warrant which has a longer expiry dates (theta value)
2nd Choose higher Delta, EG and IV compare to peers
3rd Do not choose illiquid shares as the Issuer will do arbitrage trading
4th Do not trade if you are no good. Do paper trade and buy mother share instead.

Case Study: MRCB vs MRCB WA
Step 1 Calculate the Basic Intrinsic Value:
Mother / Underlying Price = 1.41
Warrant Price = 0.22
Exercise Ratio = 1 to 1
Exercise Price = 2.30
Breakeven price = 2.52
Moneyness = OTM 38.7%
Option Style = American
Expiry Date = 18 Sept 2018

Exercise Ratio is 1 to 1.
Buy 1 warrant at RM 0.22 (you have the right to convert become mother share from the date issued until expiry date – that is American Style. For European style can only be exercised after expired in 2018)

Case study:
Buy 1 Warrant at 0.22 and Add Exercise Price 2.30 = 2.52 (total cost of owning the mother price that worth 1.41 now (it is called dumb)
Moneyness is Out of The Money 38.7%
Exercise Price 2.30- 38.7% = 1.4099 / 1.41
Means you are buying at the price of 38.7% higher than the market price (it is also dumb)

Step 2: Input the IV, EG, Delta, Theta
It is for forecasting purpose
1. Check and test the similar wa for bench mark to find the most value for money
2. Do back test to check their IV, EG, Delta Theta for all the warrants for one mother share
3. Do a back test to check the Mother Price for the past 3 to 5 years on their price movement and correlation between Mother Price and Warrants
4. Set your entry price, if the Warrant touches your entry price, execute, if not ignore and find other warrant.

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