Put Warrants Grab Spotlight as Hong Kong Stocks See-Saw

OREANDA-NEWS. January 15, 2016. Hong Kong and Chinese equity markets have seen turbulence in recent sessions due to investor concerns over the slide in the yuan and the uncertain outlook for the world’s second-largest economy. In US dollar terms, the Hang Seng Index has fallen over 8% in the year-to-date, while the Shanghai Composite Index and the CSI 300 Index have declined 17% and 16% respectively during the period.

China stocks began the year on a volatile note, as a 7% selloff last Monday and Thursday triggered two nation-wide trading halts during the week under its newly implemented circuit breaker mechanism, and wiped out more than US\\$1 trillion in value. Officials have since suspended the circuit breaker program, which was introduced in response to last summer’s rout in China equities, and came into effect at the start of the year. Policy makers have also acted quickly to shore up the country’s US\\$6.5 trillion stock market – government funds have been buying local equities, and regulators have said they would renew limits on the amount of stock major corporate shareholders can sell.

The Hang Seng Index sank 6.7% last week, the steepest decline since September 2011. On Monday, the index fell 2.8% to 19,888.50, closing below the 20,000 level for the first time since June 2013, but unexpectedly rebounded on Wednesday, while the offshore yuan headed for its biggest five-day advance on record, after data showed China’s trade surplus widened and exports recovered last month. A recovery in exports could help bolster the weakening Chinese currency, counter capital outflows and ease investor concerns over the state of the domestic economy. The trade data also suggests recent yuan weakness may be starting to boost China’s export competitiveness. Hong Kong equities would also benefit from a stronger yuan – many companies listed on the HKSE derive the bulk of their sales from the mainland, and a weaker currency reduces their profits when translated back into Hong Kong dollars.

Put Warrants – Protection in Amidst Volatility

Month-to-date, a total of S\\$107 million has been traded in SGX structured warrants, of which S\\$76 million is from Hang Seng Index warrants. Bullish investors may consider Call warrants while those investors concerned about the market falling in the short-term may consider hedging themselves with Put warrants.

The most actively traded warrant from 1 – 12 January is HSI 20400 MB EPW160128 at S\\$18 million. This is a Put warrant, linked to the movements in the HSI Futures prices, with strike level of 20,400 and an expiry date of 28 January 2016. Put warrants allow investors to potentially earn a profit when the underlying falls. Unlike call warrants whose prices tend to move in the same direction as the underlying, put warrants will tend to move in the opposite direction to the underlying, increasing in value as the underlying falls and decreasing in value as the underlying rises.

Using the last price as an indication, the Jan 2016 Hang Seng Index Futures Contract slid 7% MTD to close at a level of 19,697 on 12 Jan.  During the same period, the last price of HSI 20400 MB EPW160128 rose 229% to S\\$0.184.   This is because structured warrants offer investors the power of leverage or gearing to magnify their potential gains within a relatively short investment horizon. A percentage movement in the price of the underlying asset would therefore result in a proportionately larger percentage movement in the theoretical price of the warrants.

As a side note, investors should be aware that the value of structured warrants will decrease over time, a process known called ‘time decay’, or ‘theta’.  The theta of a warrant is not constant and will speed up as the warrant approaches its expiry. However, as can be seen from the above example, should an investor get his directional view of an underlying correct, the increase in the value of the warrant could potentially outweigh the time decay effect.
The table below details the other active warrants traded on SGX in the month-to-date.  

Specified Investment Products

Structured warrants are an example of Specified Investment Products (SIPs). The MAS has introduced measures for intermediaries to safeguard the interests of individual investors investing in SIPs, which are products with features that might be more complex in nature. Investors now have the opportunity to assess their qualifications to trade SIP or enhance their product knowledge through the SGX online portal available here.