The information in this page is reproduced with the permission of Singapore Exchange.
What is a Structured Warrant?
A structured warrant is a form of structured investment products issued by a third-party financial institution over a wide range of assets, including the shares of an un-related listed company, a basket of companies' shares or an index, and traded on SGX.
Structured warrants can be issued either as a call or put warrant. A call (put) warrant gives the holder a right, but not the obligation, to buy from (sell to) the issuer the underlying asset at a predetermined price, also known as the exercise price, on or before the expiry date, depending on the exercise style of the warrant.
In general, structured warrants enable investors to express their view of the performance of the underlying asset in a bullish or bearish market, at a significant degree of leverage over the life of the structured warrant. In addition, put warrants may be used by investors to hedge against the downside risk of one's investment holdings.
Warrants have a fixed tenure and, if not exercised, are worthless after their expiry date.
What are Call Warrants?
A call warrant gives the holder a right, but not the obligation, to buy from the issuer the underlying asset at a predetermined price, also known as the exercise price, on or before the expiry date, depending on the exercise style of the warrant.
| Position: Buying a Call | |
| Typical Market View | A bullish view of the price/level of the underlying asset over a certain time period. |
| Potential Profit | If position is unwound before maturity Difference between sale price and purchase price of the warrant If position is held till maturity date Difference between cash settlement amount (i.e. the difference between the current share price and the warrant exercise price) and purchase price of the warrant |
| Potential Loss | Total premium paid |
What are Put Warrants?
A put warrant gives the holder a right, but not the obligation, to sell to the issuer the underlying asset at a predetermined price, also known as the exercise price, on or before the expiry date, depending on the exercise style of the warrant.
| Position: Buying a Put | |
| Typical Market View | A bearish view of the price/level of the underlying asset over a certain time period. |
| Potential Profit | If position is unwound before maturity Difference between sale price and purchase price of the warrant If position is held till maturity Difference between cash settlement amount (i.e. the difference between the current share price and the warrant exercise price) and purchase price of the warrant |
| Potential Loss | Total premium paid |
There are 6 main factors which determine the fair value of a structured warrant:
- the prevailing price/level underlying asset price,
- the exercise price of the warrant,
- the volatility of the underlying asset price,
- the time to expiry of the warrant,
- the interest rate, and
- the dividend of the underlying asset.
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Factor Movement
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Effect on Theoretical Value of Warrant
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Remarks
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Put
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Price of the Underlying Asset ↑
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An upside movement in the underlying security makes a call warrant more valuable and a put warrant less valuable.
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Exercise Price of Structured Warrant ↑
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A high exercise price reduces the probability of a call warrant being exercised and increases the probability of a put warrant being exercised.
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Volatility of the Underlying Asset ↑
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The higher the price fluctuation of the underlying asset, the greater the potential for the structured warrant to trade in-the-money.
There are typically two types of volatility for a structured warrant:
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Time to Expiry of Structured Warrant ↓
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The shorter the time to expiry, the lower the probability the price of the underlying asset will move in favour of the warrant holder. That is, the time value of the call and the put warrant will decrease as they approach expiry. This relationship is however, not direct, hence, the time decay of a warrant’s value through time is not constant.
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Interest Rates ↑
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As interest rate increases, the value of the call warrant increases and the value of the put warrant decreases.
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Dividend of Underlying Asset ↑
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Cash payments on the underlying asset tend to decrease the value of a call warrant because it makes it more attractive to hold the underlying asset.
In practice, expected dividends are most often priced in the value of the structured warrants when issued by the issuer. Thus, dividend yields of the underlying asset have little impact on the prices of structured warrants on ex-dividend dates.
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The factors above work together to determine the theoretical price of a structured warrant.
The most important of these factors are the prevailing price/level of the underlying asset relative to the exercise price, the implied volatility and time to expiry. Similar to other securities, the market price of a structured warrant may also be affected by market forces, i.e. the supply of and demand for the structured warrant.
Leverage
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.
Diverse Market Access
Unlike warrants on individual stocks, index and basket warrants give you exposure to a sector or market, as their values are linked to the performances of certain benchmark indices and pre-defined baskets of shares respectively. This eliminates the need for trading in a market portfolio of individual stocks.
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.
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.
Releasing Capital for Other Investments
Call warrants may be used to free up capital invested in shares. By selling existing share holdings and purchasing a corresponding number of call warrants for a fraction of the price, you can maintain exposure to the underlying share price increase while releasing capital held in shares.
You can trade structured warrants the same way you buy and sell shares and other securities listed on SGX-ST. Simply execute the trades through your broker and there is no separate account needed for the trading of different securities. Trades are settled on the same basis as share transactions - on the third business day after the trade date.
While SGX Securities Trading provides the infrastructure for warrants to be traded, neither SGX Securities Trading nor its subsidiaries in any way guarantee the performance of the warrant issuer or the warrants issued.
Limited Life of Warrants
Warrants have an expiry date and, therefore, a limited life. A warrant may expire before your expectations are realised, making it worthless. Therefore it is essential that you select a warrant that has sufficient time to expiry to match your market expectations.
Leverage
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.
Credit Risk
Credit risk is the risk that the warrant issuer will not be able to fulfill its obligations. This occurs during the exercise of the warrants. Therefore, you should assess the credit risk associated with the warrant issuer.
Currency Risk
In the event that a warrant is denominated in a currency other than SGD, you will be subject to exchange rate fluctuations that may have an adverse effect on the value, price or return of the warrant.
Market Risk
Similar to other investments in the securities market, the market value of a warrant is susceptible to events that affect its demand and supply. Hence, the market value of your investment will fluctuate accordingly.
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.
Default on Market-Making Obligation
A warrant issuer who has committed to make a market in the warrants it issued may not fulfill its obligation due to unforeseen circumstances. Hence, you may experience liquidity risk despite a commitment from the warrant issuer to make a market.
Extraordinary Event
The warrant issuer may declare a lapse of the warrant or bring forward the expiry date. This arises out of certain circumstances such as the delisting of the underlying asset. These circumstances are outlined in the Terms and Conditions of the warrants issue.