2011-07-27 [Info] What is Warrant?

source: [Bursa Dummy]

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.