Wednesday, 27 July 2011

What is Warrant?

Warrant gives its holder the right to buy a given quantity of the underlying shares at a predetermined price (exercise price) on or before a particular date (expiry date).

If you have a company's warrant, you can either:
- exercise your right to buy the company's share at the exercise price, OR
- sell the warrant in the open market

Thus, a warrant is a right, not an obligation to buy a company's share.

There are 2 types of warrant: call warrant and put warrant. A call warrant represents a specific number of shares that can be purchased from the issuer at a specific price, on or before a certain date. A put warrant represents a certain amount of equity that can be sold back to the issuer at a specified price, on or before a stated date.

In Bursa Malaysia, only call warrant is allowed.

Warrant can be issued by the listed company or by other banks/security films. In Bursa, I notice that those warrants issued by the parent company are called company warrants and their name end with -WA, -WB, -WC etc. For the warrants issued by other banks/security films, they are generally referred to as call warrants and the name end with -CA, -CB, -CC etc. By definition, both -WA and -CA are actually call warrants.

A company issues warrant to raise more money. When these company warrants are exercised, new company shares will be given to the investors. In other words, the total company shares will increase and earning will be diluted. For call warrants issued by other banks/security films, when they are exercised, investors will not get the company's shares. It's more like a speculating or gambling tool.

Why do investors want to invest in warrants? It is mainly because warrant can give higher returns compared to the company share (aka mother share). While the potential gain is higher, the potential loss is also higher. Thus it is considered a higher risk investment.


Let's take SP Setia's share and warrant as real example.

As of 21 July, SPSETIA share price closed at RM3.75. Its warrant SPSETIA-WB price is at RM0.89.

The next day, SPSETIA surged 32sen to RM4.07, a gain of 8.5%. At the same time, SPSETIA-WB surged 15sen to RM1.04, a gain of 17%.

Though SPSETIA-WB gain 17sen less, but it actually outperformed its mother share SPSETIA by 100% (gain 17% vs 8.5%). Both mother share and warrant usually will move in the same direction. As warrant price is much lower than the mother share, it provides greater leverage for the investment.

There are a few terms that we will usually encounter when investing in warrant:

- Exercise price:  the price warrant holder pay to buy the company share
- Conversion ratio:  the number of warrant(s) needed to buy one company share
- Expiry date:  the date the warrant will expire
- Gearing:  indicate the level of leverage
- Premium:  indicate the difference between mother share price & warrant price if warrant is exercised.

Let's take SPSETIA as example again:

On 22 July, mother share SPSETIA RM4.07, SPSETIA-WB RM1.04.

- Exercise price:  RM2.99 (fixed)
- Conversion ratio:  1 warrant for 1 share
- Expiry date:  21 Jan 2013
- Gearing:  3.91 (4.07/1.04) The higher the gearing, the higher the leverage (higher potential gain/lost)
- Premium:  -0.98% [(2.99+1.04-4.07)/4.07] x 100. The lower the premium, the "cheaper" is the warrant

If I have 1000 SPSETIA-WB bought earlier at RM0.90, and I exercise my right to convert all of them into SPSETIA shares on 22 July, I need to pay the exercise price of RM2.99 for each converted shares. Thus the total cost of conversion is RM2.99 x 1000 = RM2990 (excluding other trading cost).

For this case, the total cost for this 1000 SPSETIA shares is (RM0.90 + RM2.99) x 1000 = RM3890. If I immediately sell all of them on 22 July at RM4.07, I'll gain RM107 (RM4070-RM3890). By right I can't sell the converted mother shares on the same day as the conversion date because conversion usually takes few weeks time to complete. This is just example.

However, if I do not wish to exercise the warrant right, I can sell the warrant directly in the stock market like most warrant holders will do. If I manage to sell all 1000 SPSETIA-WB on 22 July at price RM1.04, I'll gain (RM1.04-RM0.90) x 1000 = RM140.

After the expiry date and if you still hold the warrant, then you will lose all of them and won't get a single cent back. Thus it is advisable not to buy warrant which is close to expiry date, as the trading volume is usually low and you won't get much choices and time left. You may be forced to exercise the warrant at high premium (buy the mother shares at high price) or you will lose everything.

13 comments:

  1. I had spoken to the PBB share staff recently. Call warrant -CA,CB etc, cannt be convert to mother share, u can either sell/buy call warrant on stock market or hold it till on expiry date and conversion to money will pay to holder by calculation :
    (mother share price - exercise price)/conversion ratio x unit have,
    mostly will be negative, means zero will be paid than.
    For Warrant, WA,WB,etc, can convert to mother share at anytime as u said.

    ReplyDelete
  2. Thanks for the feedback and clarification!

    So that means -CA holder has no right to convert to mother shares at any time? It's against the definition of warrant.

    ReplyDelete
  3. That is what i understand from the staff.

    ReplyDelete
  4. May I have some question here? As u said, the warrant like WA- can convert to mother share anytime..no need to wait close to maturity date right? could I convert it into mother share via onlie trade system or I necessary need to call my broker to do it? I had some KPJ-WA given by the parent company..If I convert it into the parent share..the calculation for paid is quantity*conversion price is it? any other charges besides this? brokerage or ? Sry for asking too many question..but Im really confuse with this..need ur favor as soon as possible..thanks alot..!!!

    ReplyDelete
  5. suBSub, personally I have no experience in converting warrants to mother shares. But for what I know, some company warrant can be converted at anytime but some at specific time. I don't think u can do it online. Charges by broker is around RM2 +/- few cents for cheque. It takes about at least 3 weeks to process though. U can call your broker to confirm. Do share with me if u have new info on warrant conversion.

    ReplyDelete
  6. Dummy, Thanks for ur answer. i havent ask my resmier but I think u are right! I have another question about call warrant..lets say DRBHCOM-CF,it's Conversion Price is RM2; Conversion Ratio is 3:1, my question is if I bought it from the market 0.365, the maturity date is 30/03/2012...the if the last date the mother share close at RM3..I'm losing the money right? how many I losing? and how to calculate it? what's the point of conversion ratio 3:1? it is settle by cash..this making me so confusing! Wish u can help me ever again!

    ReplyDelete
  7. What's the point of conversion ratio? Good question, I also want to know. Anyway, I think this call warrants thing is specially designed for "gamblers" to punt and for financial institution who issue it to earn big money. With the conversion ratio, it makes the unit price lower, eg. if 1:1 is RM1, then 1:3 is 33sen and 1:5 is 20sen. The lower the unit price, the more we can earn (or lose) and the more exciting it is.

    For yr DRBHCOM-CF, one unit is 0.365. To convert to one mother share, you need 3 units (0.365x3) + conversion price of RM2 = RM3.095. If the mother share price is at RM3, then you will lose RM0.095 for every 3 units of DRBHCOM-CF. Thus, you will lose RM0.095/3 = RM0.032 for each unit of DRBHCOM-CF, excluding the broker charge.

    ReplyDelete
  8. ok i get it! Thanks dummy! Btw does call warrant possible to turn out be trash paper? I meant zero money get back after maturity date. Another question is, call warrant is automatic convert and settle by cash when date is over right?

    ReplyDelete
  9. If u refer to the comment posted by teh above, yes, your call warrant can become trash paper which mean u lose all the money used to buy those call warrants earlier. I think they will be converted automatically at expiry date - If got positive, then they will pay u. If negative, then u lose all the CW. Again, I have no experience in this, so pls confirm with expert if u r going to play this game.

    ReplyDelete
  10. could you kindly write about H warrants. ha,hb,etc. how do we value them? cant find any write up explaining about it, tq

    ReplyDelete
  11. Hi, can i confirm whether my understanding of warrants is correct?
    - Company warrant : Must be sold or converted before expiry. If still hold on to it after expiry, it is worthless.

    - Call warrants : can be held until expiry. Upon expiry, will be automatically converted to cash settlement.

    ReplyDelete
  12. Thx for the information it is very helpful and easy to understand.

    ReplyDelete