OREANDA-NEWS. April 27, 2015. Structured warrants on the Hang Seng Index (HSI) is the most actively traded segment of the warrants market on SGX.

In the month-to-date, investors seeking downward price protection on the Hang Seng Index have been preferring end-of-May expiry periods with a strike price of 26,600, whilst the most active upside play has been an end-of-June expiry with a strike price of 26,000. The Hang Seng Index is currently trading circa 28,000. HSI warrants have attracted interest from investors keen to capitalise on the trading opportunities from the short-term and intra-day index volatility recently generated in China and Hong Kong. The Shanghai Composite Index has more than doubled over the past 12 months and the buying frenzy has also sent the Hang Seng Index to seven-year highs, as investors used the link between the exchanges to capitalise on the valuation gap.  Market-makers hedge their risk in index warrants through the underlying tradeable futures and thus, price movements in HSI warrants tend to follow the HSI futures price.

Structured Warrants are products issued by a financial institution to enable investors to leverage on the upside and downside price movement of the underlying asset, which not only includes the Hang Seng Index, but also the Nikkei 225, Straits Times Index or blue-chip stocks.

Call warrants offer the right to “buy” the underlying and benefit from the upside price movement. Put warrants benefit when the underlying declines. Put warrants represent an efficient means for investors to participate in the decline of the underlying index/stock or hedge against a decline in their portfolio holdings. Unlike investors who borrow stock to short-sell or short derivatives such as futures, options or CFDs, warrants investors are not subject to margin requirements and do not risk more than their initial investment.

The value of a warrant can be broken into 2 components, which include the intrinsic value and the time value. The intrinsic value fluctuates with the underlying asset price and is the difference between the spot price of the underlying asset and the strike price of the warrant. Time value is the amount of premium above the intrinsic value and it decreases over the life of the warrant.

Some of the key factors that influence the warrant price after it is listed are displayed in the table below.

Key Factors*

Change in Warrant Value

Call

Put
Underlying Asset Price Increases

Increase

Decrease
Implied Volatility of Underlying Asset Increases

Increase

Increase
Time to Expiry of Warrant Decreases

Decrease

Decrease

*Other factors like dividend yield and interest rate may also affect the price of a warrant, but to a lesser extent.

Strike Price

Strike price is the pre-determined or fixed price at which the warrant holder can buy (for call warrants) or sell (for put warrants) the underlying asset. The HSI put warrant (HSI 26600 MB EPW150528) expiring on 28 May 2015 has an exercise price of 26,600, and the HSI call warrant (HSI 26000 MB ECW150629) expiring on 29 June 2015 has an exercise price of 26,000.

A structured call warrant is said to be “in-the-money” if the market price of the underlying asset is higher than exercise price of the warrant, and “out-of-the-money if the market price of the underlying asset is lower than exercise price of the warrant.

On the other hand, a structured put warrant is said to be “in-the-money” if the market price of the underlying asset is lower than exercise price of the warrant, and “out-of-the-money” if the market price of the underlying asset is higher than exercise price of the warrant

The position of a warrant – whether it is “in-the-money” or “out-of-the-money” – can change according to moves in the underlying asset price.

Most Active HSI Call and Put Warrants in April to-date

  HSI Call Warrants MTD Traded Value S\\$
1. HSI 26000 MB ECW150629 49,575,426
2. HSI 28600 MB ECW150528 33,687,876
3. HSI 26000 UB ECW150629 9,614,691
4. HSI 26200 MB ECW150828 8,534,333
5. HSI 25000 MB ECW150429 7,603,335
6. HSI 29000 MB ECW150629 6,723,570
7. HSI 25400 MB ECW150528 5,756,445
8. HSI 27800 MB ECW150528 4,985,449
9. HSI 24800 MB ECW150528 3,945,759
10. HSI 25200 UB ECW150429 2,645,559

Source: SGX My Gateway (data as of 21 April 2015)

  HSI Put Warrants MTD Traded Value S\\$
1. HSI 26600 MB EPW150528 32,454,892
2. HSI 24000 UB EPW150828 5,858,200
3. HSI 26200 MB EPW150629 5,401,958
4. HSI 24000 MB EPW150528 4,333,322
5. HSI 24600 MB EPW150528 2,815,031
6. HSI 27400 MB EPW150528 2,779,201
7. HSI 23200 UB EPW150629 1,935,093
8. HSI 24200 MB EPW150429 878,364
9. HSI 24800 VT EPW150429 504,200
10. HSI 26000 VT EPW150629 299,900

Source: SGX My Gateway (data as of 21 April 2015)

An upward movement in the underlying asset makes a call warrant/option more valuable and a put warrant/ option less valuable. In terms of the implied volatility of the underlying asset, the higher the price fluctuation of the underlying asset, the greater the potential for the warrant/option to trade in-the-money and hence, the increase in both call and put warrant values. The shorter the time to expiry, the lower the possibility that the underlying asset’s price moves in favour of the warrant holder. All else being equal, this results in a lower time value of the warrant.

The variety of Structured Warrants allow individual investors to assume positions that are based on their risk profiles and investment objectives. For example, a warrant which is in-the-money (that is, the exercise price is lower than the underlying market price) may be more responsive to movements in the underlying asset but offers less leverage compared to warrants which are out-of-the-money. Warrants that have a longer time-to-expiry tend to have slower time decay than shorter-dated warrants, and may be more suited for longer-term investors.

Risks of Structured Warrants

Besides the benefits, investors should be mindful of potential risks of structured warrants trading. The key risk factors are:

  • Market Risk – prices and corresponding values can move against expectations and past performances do not guarantee future results.
  • Leverage – besides multiplying gains, losses may be magnified when the underlying asset moves adversely. Investors should have in mind cut-loss levels and proportion of their overall investment capital placed in leveraged products.
  • Limited Lifespan – “Time decay” is the decline in the value of the warrant as it trades towards expiry, which accelerates particularly in the last one month of the warrant’s lifespan. Time decay may be offset by a rising intrinsic value, that is, when the underlying moves in favour of the investor. Investors should choose warrants with expiry periods longer than their investment horizon.
  • Issuer Risk – Warrant holders are unsecured creditors of issuers and have no preferential claim in the event the issuers are unable to fulfill their obligations.

Structured warrants are settled on the same basis as share transactions, which is on the third business day after the trade date, or T+3.

Under MAS’ guidelines to enhance safeguards for retail investors, brokers must assess if investors have the relevant knowledge and experience before they can invest in “Specified Investment Products”.

SIPs are products that have structures, features and risks that may be more complex and include structured warrants, certain ETFs, futures and options. Investors who wish to trade warrants need to complete a customer account review with their respective broker.

Alternatively, investors may assess their qualifications to trade SIP or enhance their product understanding through the SGX online education program – click here for more information.

SGX recently cut its trading and clearing fees for warrants trades.  Investors can gain participation in the price performance of the Hong Kong and China markets through call and put warrants for a cost of 0.5bps (excluding brokerage and other transaction costs).

To increase awareness and transparency on warrants trading in its market, SGX recently started featuring outstanding position reports from issuers on a weekly basis.  Market participants can refer to these reports for information on buy and sell trades as well as market makers' principal positions.