If you are already playing warrants, I don’t think I need to explain to you what warrants are but to those newbies there, let’s just say it’s a two edge sword.  Its sharp, it cuts and it’s dangerous.  Treat it with respect, it becomes adrenaline rushing and extremely rewarding.

There are essentially two  kinds of warrants – company warrants and structured warrants.

 Company warrants are issued  by the listed companies themselves, usually thrown in free as sweeteners for investors to subscribe to their right issues while structured warrants are issued by third parties such as Maybank, CIMB, Kenanga, OSK, AmBank and Macquarie.  Unlike company warrants, structured warrants need not be converted to the underlying shares and any monies due to you will be cash settled  upon expiry and banked into your account, whereas for company warrants you need to covert to the underlying shares upon expiry else your warrants will be delisted and you can kiss you money goodbye.   This article I am sharing with you is about the rules and benefits of playing warrants.

First the Benefits:

1.        Offers tremendous gains (or losses) with limited amount of money eg. If the mother share(underlying) is trading at RM1.00 and the warrant is only 10 sen, that would mean the gearing is 10x.  if you had RM5,000, you can only buy 50 lots or 5000 units of share X, on the other hand you can buy 500 lots or 50,000 units of warrant x with the same amount

2.       Often you will see when mother share increase, the warrants will run parallel-mother increase 10 sen, son(warrant) also increase 10 sen; 50% increase compared to the mother (mother 10 sen , son 5 sen and sometimes occasionally son increase more than the mother.

3.       Hedging opportunities.  If you are holding the mother share and it has drop a lot and you think it will rebound, buying the son will give you an opportunity to recuperate without doubling the exposure.   

Let’s look at a REAL LIFE Scenario. Lets take a  look at a structure warrant (structure warrants are more interesting in the sense that gearing is much higher and the warrants much cheaper)

 Case Study: TopGlove CV (issuer: AmBank, expiry 15/4/16, ex price RM6.85, ex ratio:8)

On 5/12/15 Top Glove price saw an increase of 10 bids (20 sen) from RM10.12 to 10.32 netting an increase of 1.98%.  With RM5,060 you will be able to purchase 5 lots (500units) of Top Glove @RM10.12 and at the closing price of RM10.32, your profit will be a miserly RM100!  RM5,000 investment for a miserly RM100 and after minus brokerage fee, stamp duties and GST, what have you left with? A cup of Starbucks?

Now with the same RM5,000, you can instead buy 130 lots of Top Glove warrant – CV @ 38.5sen and with the closing price of 46sen, your profit now is actually RM975.  Not bad at all. Now which do you prefer RM975 or RM100? It is worth noting that the warrant price increase is almost running parallel with the mother, 1 bid (0.02sen for shares above RM10) results in 0.5sen increase in warrant (Delta92%).

This is financing leveraging at its best and put it another way, it is almost like margin financing without the worries of margin call and hefty interest charges.  Instead of just being able to purchase 5 lots, now your purchasing ability is a phenomenal 26X (130/5) and increase profits of 9.75X !

The Rules

1.Do Not Buy When the Market Makers are no longer there.

High volume doesn’t necessarily mean is good, low volume doesn’t mean must avoid.  As a warrant price moves in tandem with the mother shares, volume only becomes a concern to you when the issuer has fully sold out its shares. Reputable warrant issuers/market makers will commit to buy and sell according to a set of rules or algorithms even though it is thinly traded.  When the warrants are fully sold, prices may be inflated or suppressed down depending on conditions.  That is why I prefer thinly traded structured warrants than big volumes warrants.   

2.Be Mindful of Expiry Dates But you can still trade even till the Last Day.

Warrants will lose some of its value with time.  This is known as time decay or Theta, however as long as the market makers are there to provide active offers, it is still safe to trade until the last day. How do you know they are still there? Look at the Bid and Ask (Buy & Sell) volume, if they are about similar in volume they are most probably there.  One of the issuers in fact has a website that provides live matrix on the prices of it warrants corresponding with its mother shares-what is their bid and ask price if mother shares does up by 1,2,3,4,5  bids and so forth.

3.Day Trade for Structured Index Warrants

Structured index warrants such as HSI and China50 can be extremely volatile, you can lose 25% or more  of your share prices (similarly you can gain 25% or more) while you sleep as the HSI opens negative 500 points.  Therefore day trading helps to omit this possibility.  It is better to take profit or take minimal loss the same day than to test fate (unless you are 100% certain of tomorrow index performance).  It is with this volatility that HSI becomes an interesting play.  You can actually trade  the same warrant 3 or 4 times in some good days or even play put and call simultaneously and make money from both of them.  At this time of writing, KLCI is lackluster and as such a better option would be HSI.

4.Other structured warrants hold max 2 weeks if no/negative movement.

Unless you have multi millions and doesn’t mind your money sitting idle, whatever warrants (even shares for that matter) must be working for you.  If the warrant that you bought is not moving up in two weeks, isn’t it time to try another? If your staff that you hired has not been working at all, are you going to give him another two weeks in hope that he’ll change?  IF you are a trader, two weeks is more than long enough to know whether the share that you bought is moving or not. Investing is another story and this article is not applicable to it.

5.Always Have a Fixed Trading Plan

Your trading plan must have a stop loss and trailing stops or at least target price.  For example, if you bought a warrant for 21sen, your cut loss maybe 20 sen and if it reach 22sen,  your first trailing stop may be 21.5sen, and when it reaches 25 sen, your next stop maybe 24sen.   Follow this religiously and your losses will be mitigated, capital preserved and profits continue to ride.

However if you are trading the HSI warrants, you may want to tweak your strategies slightly.  Bear in mind Hang Seng’s break is from 12 to 1 noon while ours is 12.30 to 2.30pm.  Many things can happen during 1pm to 2.30pm while Hang Seng is trading when we are not.  Depending on the occasions, you may want to break your trading in two sessions- closing your trading the same and buying again in the next session.

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