INVESTOR
EDUCATION
INVESTOR
EDUCATION
WARRANTS
Warrants are an instrument which gives investors the right – but not the obligation – to buy or sell the underlying asset at a pre-set price on or before a specified date. There are two main types of warrants: equity warrants and derivative warrants, which are subject to different provisions of the Listing Rules in Hong Kong.
Equity warrants
Issued by a listed company and give holders the right to subscribe for equity securities of the issuer. Equity warrants are often issued together with new shares in IPOs, or distributed together with the shares acquired for any dividend payment, bonus issue or rights issue. Equity warrants have a life of one to five years. Upon exercise, the listed company will issue new shares to their holders and collect extra capital. The issuer of a warrant must specify whether it is settled by cash or by physical delivery of the underlying assets.
Derivative warrants
Issued by a third party, generally an investment bank, independent of the issuer of the underlying assets. They have a life of six months to five years. The underlying assets of derivative warrants include ordinary shares, market indices, currencies and baskets of shares. The issuer of derivative warrants may not be the issuer of the underlying assets but should hold or have a right to hold the underlying assets. The right conferred by a derivative warrant may be the right to buy (call warrant) or the right to sell (put warrant).
Derivative warrants can be linked to a single security or a basket of securities, stock indices, currencies, commodities or futures contracts (like crude oil futures). Almost all derivative warrants currently traded in Hong Kong are cash-settled. When a physically settled call derivative warrant on a single stock is exercised, the warrant holder will receive the underlying stock from the issuer. Unlike equity warrants, no new shares will be issued. Furthermore, every derivative warrant has a designated liquidity provider to help improve the liquidity of the instrument in the market.
The price of a derivative warrant at expiry mainly rests with the price of the underlying assets. However, so long as a derivative warrant remains valid, its price will be affected by other factors in addition to the underlying assets’ price. They include the volatility of the underlying assets’ price, the exercise price, the time remaining to expiry, interest rates and expected dividend payments on the underlying assets, etc. Like other securities, the price of a derivative warrant may also be affected the supply of and demand for the derivative warrant itself.
Since derivative warrants can have great product variety, large warrant markets in the world are usually mainly derivative warrant markets. The equity warrant markets are usually of a much smaller scale.
Attributes
Issuer: A warrant can be issued by a listed company (i.e. subscription warrant) or a third party such as a financial institution (i.e. derivative warrant).
Underlying asset: It can be a single stock, a basket of stocks, an index, a currency, a commodity, a futures contract (e.g. oil futures) etc.
Types of rights: Don’t mix up a call warrant with a put warrant. A call warrant gives you the right to buy whereas a put warrant gives you the right to sell the underlying asset.
Exercise price: The price at which you buy or sell the underlying asset in exercising a warrant.
Conversion ratio: This refers to the number of units of the underlying asset exchanged when exercising a unit of a warrant. Normally, in Hong Kong a derivative warrant on shares has the ratio of 1 (i.e.one warrant for one share) or 10 (i.e.10 warrants for one share).
Expiry date: The date on which a warrant will expire and become worthless if the warrant is not exercised.
Exercise style: With an American warrant, you can exercise to buy/sell the underlying asset on or before the expiry date. Whereas a European warrant allows exercise on the expiry date only.
Settlement: A warrant can be settled by cash or physical delivery upon exercise.
Trading policy: Derivative warrants are traded on the Exchange during trading hours in board lot multiples settled on T+2 (T being the transaction day).
Risk disclosure
Derivative warrant trading involves high risks and is not suitable for every investor. Investor should understand and consider the following risks before trading in derivative warrants.
Issuer risk: Derivative warrant holders are unsecured creditors of the issuer and they have no preferential claim to any assets an issuer may hold.
Gearing risk: Although derivative warrants often cost less than the price of the underlying assets, a derivative warrant may change in value to a much greater extent than the underlying assets. Although potential return on derivative warrants may be higher than that on the underlying assets, it should be noted that in the worst case the value of derivative warrants may fall to zero and holders may lose their entire investment amount.
Limited life: Unlike stocks, derivative warrants have an expiry date and therefore a limited life. Unless the derivative warrants are in-the-money, they become worthless at expiration.
Time decay: So long as other factors remain unchanged, the value of derivative warrants will decrease over time. Therefore, derivative warrants should never be viewed as products that are bought and held as long term investments.
Market forces: In addition to the basic factors that determine the theoretical price of a derivative warrant, derivative warrant prices are also affected by the demand for and supply of the derivative warrants. This is particularly the case when a derivative warrant issue is almost sold out and when there are further issues of an existing derivative warrant.
Turnover: High turnover should not be regarded as an indication that a derivative warrant’s price will go up. The price of a derivative warrant is affected by a number of factors in addition to market forces, such as the price of the underlying assets and its volatility, the time remaining to expiry, interest rates and the expected dividend on the underlying assets.
For the basic knowledge and trading mechanism of warrants, please refer to the information provided by Investor and Financial Education Council. You should pay careful attention to the Liability Statement section on the homepage of the website of The IFEC at (www.ifec.org.hk) when referring to information using this link.
WARRANTS
Warrants are an instrument which gives investors the right – but not the obligation – to buy or sell the underlying asset at a pre-set price on or before a specified date. There are two main types of warrants: equity warrants and derivative warrants, which are subject to different provisions of the Listing Rules in Hong Kong.
Equity warrants
Issued by a listed company and give holders the right to subscribe for equity securities of the issuer. Equity warrants are often issued together with new shares in IPOs, or distributed together with the shares acquired for any dividend payment, bonus issue or rights issue. Equity warrants have a life of one to five years. Upon exercise, the listed company will issue new shares to their holders and collect extra capital. The issuer of a warrant must specify whether it is settled by cash or by physical delivery of the underlying assets.
Derivative warrants
Issued by a third party, generally an investment bank, independent of the issuer of the underlying assets. They have a life of six months to five years. The underlying assets of derivative warrants include ordinary shares, market indices, currencies and baskets of shares. The issuer of derivative warrants may not be the issuer of the underlying assets but should hold or have a right to hold the underlying assets. The right conferred by a derivative warrant may be the right to buy (call warrant) or the right to sell (put warrant).
Derivative warrants can be linked to a single security or a basket of securities, stock indices, currencies, commodities or futures contracts (like crude oil futures). Almost all derivative warrants currently traded in Hong Kong are cash-settled. When a physically settled call derivative warrant on a single stock is exercised, the warrant holder will receive the underlying stock from the issuer. Unlike equity warrants, no new shares will be issued. Furthermore, every derivative warrant has a designated liquidity provider to help improve the liquidity of the instrument in the market.
The price of a derivative warrant at expiry mainly rests with the price of the underlying assets. However, so long as a derivative warrant remains valid, its price will be affected by other factors in addition to the underlying assets’ price. They include the volatility of the underlying assets’ price, the exercise price, the time remaining to expiry, interest rates and expected dividend payments on the underlying assets, etc. Like other securities, the price of a derivative warrant may also be affected the supply of and demand for the derivative warrant itself.
Since derivative warrants can have great product variety, large warrant markets in the world are usually mainly derivative warrant markets. The equity warrant markets are usually of a much smaller scale.
Attributes
Issuer: A warrant can be issued by a listed company (i.e. subscription warrant) or a third party such as a financial institution (i.e. derivative warrant).
Underlying asset: It can be a single stock, a basket of stocks, an index, a currency, a commodity, a futures contract (e.g. oil futures) etc.
Types of rights: Don’t mix up a call warrant with a put warrant. A call warrant gives you the right to buy whereas a put warrant gives you the right to sell the underlying asset.
Exercise price: The price at which you buy or sell the underlying asset in exercising a warrant.
Conversion ratio: This refers to the number of units of the underlying asset exchanged when exercising a unit of a warrant. Normally, in Hong Kong a derivative warrant on shares has the ratio of 1 (i.e.one warrant for one share) or 10 (i.e.10 warrants for one share).
Expiry date: The date on which a warrant will expire and become worthless if the warrant is not exercised.
Exercise style: With an American warrant, you can exercise to buy/sell the underlying asset on or before the expiry date. Whereas a European warrant allows exercise on the expiry date only.
Settlement: A warrant can be settled by cash or physical delivery upon exercise.
Trading policy: Derivative warrants are traded on the Exchange during trading hours in board lot multiples settled on T+2 (T being the transaction day).
Risk disclosure
Derivative warrant trading involves high risks and is not suitable for every investor. Investor should understand and consider the following risks before trading in derivative warrants.
Issuer risk: Derivative warrant holders are unsecured creditors of the issuer and they have no preferential claim to any assets an issuer may hold.
Gearing risk: Although derivative warrants often cost less than the price of the underlying assets, a derivative warrant may change in value to a much greater extent than the underlying assets. Although potential return on derivative warrants may be higher than that on the underlying assets, it should be noted that in the worst case the value of derivative warrants may fall to zero and holders may lose their entire investment amount.
Limited life: Unlike stocks, derivative warrants have an expiry date and therefore a limited life. Unless the derivative warrants are in-the-money, they become worthless at expiration.
Time decay: So long as other factors remain unchanged, the value of derivative warrants will decrease over time. Therefore, derivative warrants should never be viewed as products that are bought and held as long term investments.
Market forces: In addition to the basic factors that determine the theoretical price of a derivative warrant, derivative warrant prices are also affected by the demand for and supply of the derivative warrants. This is particularly the case when a derivative warrant issue is almost sold out and when there are further issues of an existing derivative warrant.
Turnover: High turnover should not be regarded as an indication that a derivative warrant’s price will go up. The price of a derivative warrant is affected by a number of factors in addition to market forces, such as the price of the underlying assets and its volatility, the time remaining to expiry, interest rates and the expected dividend on the underlying assets.
For the basic knowledge and trading mechanism of warrants, please refer to the information provided by Investor and Financial Education Council. You should pay careful attention to the Liability Statement section on the homepage of the website of The IFEC at (www.ifec.org.hk) when referring to information using this link.
