KUALA LUMPUR: Structured call warrants may be especially lucrative for investment bankers at the moment, but not as palatable for retail investors in the current conditions, with relatively higher prices and lower upside potential.
“I would not advise anyone to go into warrants at the moment, especially short-term warrants with a tenure of less than 12 months,” said Alan Voon, CEO of Warrants Capital Sdn Bhd.
The cost of higher volatility has already been priced into the warrants, according to Voon.
“Is volatility high at the moment? Yes. Are costs for warrant issuers higher? Yes. Therefore, the issuers will quote warrants at higher prices to factor in their higher costs,” he said.
“Traders will be hard pressed to make gains unless the market moves substantially in their favour because the volatility has been priced in. Even if the movement is in the right direction, if it is small, there will be no room for profit,” said Voon.
On a more general note, Voon said it is disadvantageous to buy warrants that have just been issued.
“It is better to let time value decay. Time value tends to be the highest in the first two months of the warrant’s life.”
He said the time value of a warrant decays in a non-linear manner; flat at the beginning and accelerating towards the end of its life.
Voon said: “The way warrants are marketed on Bursa Malaysia, the price tends to be high at the beginning due to a lack of competition.
“In theory, in a perfectly competitive market, the greater the proportion of the warrants held by the issuer, the better. In practice, however, there is a relatively high bid-ask spread for warrants because issuers do not want to cross the spread as they need to make a profit.
“Even if the share price moves in the right direction, there has to be a spike to justify buying a warrant early [soon after it is issued].”
Voon suggested Delta-1 products as an alternative to structured call warrants. “Callable bull/bear contracts (CBBC) and Delta-1 products are better from the perspective of the player,” said Voon, but noted that these products are not readily available in Malaysia.
CBBCs are traded on the Hong Kong Stock Exchange and are a type of structured product that closely tracks the performance of the underlying asset (delta close to one), although if the underlying asset trades close to the call price CBBCs may become more volatile.
Bull contracts have a call price equal to or above the strike price while bear contracts have a call price equal to or below the strike price.
“The call warrant business is very lucrative for the investment banks,” said Voon.
Call warrants are basically seen as a zero-sum game. Ignoring hedging and transaction costs, if the investment banks are making money, overall, this suggests investors must be losing the same amount of money.
While warrants allow investors to tap into the volatility of an underlying stock relatively cheaply, on the whole, the risk to return is very high.
Another analyst said: “The timing may not be the best for investors to have picked up these warrants.”
He explained that investors who buy into call warrants have to rely on bullish markets, but that does not seem to be the case based on current market sentiment for 2012.
On the other hand, this is a good deal for the investment banks, said the analyst. Just like an IPO, banks benefit the most if they issue call warrants when the market is at its peak.
Furthermore, the window to arrive at the settlement price for the call warrants is quite restrictive, typically five market days leading up to and including the expiry date.
This sometimes opens up the stock to unusual price volatility.
On Aug 1, The Edge Financial Daily reported unusual price movements of DRB-Hicom Bhd shares during the exercise period of DRB-Hicom’s call warrants issued by OSK Investment Bank Bhd.
The stock plummeted 14% or 33 sen to RM1.95 in the final minutes of trading, which was coincidentally the strike price of the warrants. The share price eventually rebounded allowing investors to recoup their losses.
“A good time to buy warrants will be after the election,” said Voon who pointed out that the coming polls have fuelled volatility in the market which is making the warrants relatively expensive at the moment.
Once speculative buys have been sold down following the election, warrants will become much more attractive.
CIMB Investment Bank Bhd recently issued eight call warrants on the underlying shares of AirAsia Bhd, DiGi.Com Bhd, DRB-Hicom Bhd, Hartalega Holdings Bhd, IJM Corp Bhd, Malaysian Bulk Carriers Bhd, Proton Holdings Bhd and Malaysia Marine and Heavy Engineering Bhd.
The European-style cash-settled warrants are with tenures of one year and an issue size of up to 50 million, each priced at 15 sen.
This article appeared in The Edge Financial Daily, December 9, 2011.
“I would not advise anyone to go into warrants at the moment, especially short-term warrants with a tenure of less than 12 months,” said Alan Voon, CEO of Warrants Capital Sdn Bhd.
The cost of higher volatility has already been priced into the warrants, according to Voon.
“Is volatility high at the moment? Yes. Are costs for warrant issuers higher? Yes. Therefore, the issuers will quote warrants at higher prices to factor in their higher costs,” he said.
“Traders will be hard pressed to make gains unless the market moves substantially in their favour because the volatility has been priced in. Even if the movement is in the right direction, if it is small, there will be no room for profit,” said Voon.
On a more general note, Voon said it is disadvantageous to buy warrants that have just been issued.
“It is better to let time value decay. Time value tends to be the highest in the first two months of the warrant’s life.”
He said the time value of a warrant decays in a non-linear manner; flat at the beginning and accelerating towards the end of its life.
Voon said: “The way warrants are marketed on Bursa Malaysia, the price tends to be high at the beginning due to a lack of competition.
“In theory, in a perfectly competitive market, the greater the proportion of the warrants held by the issuer, the better. In practice, however, there is a relatively high bid-ask spread for warrants because issuers do not want to cross the spread as they need to make a profit.
“Even if the share price moves in the right direction, there has to be a spike to justify buying a warrant early [soon after it is issued].”
Voon suggested Delta-1 products as an alternative to structured call warrants. “Callable bull/bear contracts (CBBC) and Delta-1 products are better from the perspective of the player,” said Voon, but noted that these products are not readily available in Malaysia.
CBBCs are traded on the Hong Kong Stock Exchange and are a type of structured product that closely tracks the performance of the underlying asset (delta close to one), although if the underlying asset trades close to the call price CBBCs may become more volatile.
Bull contracts have a call price equal to or above the strike price while bear contracts have a call price equal to or below the strike price.
“The call warrant business is very lucrative for the investment banks,” said Voon.
Call warrants are basically seen as a zero-sum game. Ignoring hedging and transaction costs, if the investment banks are making money, overall, this suggests investors must be losing the same amount of money.
While warrants allow investors to tap into the volatility of an underlying stock relatively cheaply, on the whole, the risk to return is very high.
Another analyst said: “The timing may not be the best for investors to have picked up these warrants.”
He explained that investors who buy into call warrants have to rely on bullish markets, but that does not seem to be the case based on current market sentiment for 2012.
On the other hand, this is a good deal for the investment banks, said the analyst. Just like an IPO, banks benefit the most if they issue call warrants when the market is at its peak.
Furthermore, the window to arrive at the settlement price for the call warrants is quite restrictive, typically five market days leading up to and including the expiry date.
This sometimes opens up the stock to unusual price volatility.
On Aug 1, The Edge Financial Daily reported unusual price movements of DRB-Hicom Bhd shares during the exercise period of DRB-Hicom’s call warrants issued by OSK Investment Bank Bhd.
The stock plummeted 14% or 33 sen to RM1.95 in the final minutes of trading, which was coincidentally the strike price of the warrants. The share price eventually rebounded allowing investors to recoup their losses.
“A good time to buy warrants will be after the election,” said Voon who pointed out that the coming polls have fuelled volatility in the market which is making the warrants relatively expensive at the moment.
Once speculative buys have been sold down following the election, warrants will become much more attractive.
CIMB Investment Bank Bhd recently issued eight call warrants on the underlying shares of AirAsia Bhd, DiGi.Com Bhd, DRB-Hicom Bhd, Hartalega Holdings Bhd, IJM Corp Bhd, Malaysian Bulk Carriers Bhd, Proton Holdings Bhd and Malaysia Marine and Heavy Engineering Bhd.
The European-style cash-settled warrants are with tenures of one year and an issue size of up to 50 million, each priced at 15 sen.
This article appeared in The Edge Financial Daily, December 9, 2011.
