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Structured Warrants

Quick Guide To Structured Warrants

  1. What Is A Structured Warrant?

  2. What Are the Types of Warrants?

  3. How to read Warrants symbols?

  4. What Are The Features And Benefits Of Investing In Structured Warrants?

  5. How Do I Exercise Structured Warrants?

  6. What Are The Risks Involved?

  7. How Are Warrants Priced?

  8. What Are The Factors Affecting Warrant Prices?

  9. A Case Study: How Do I Select A Warrant?

  10. How Do I Read Warrants Expiry and Settlement?

  11. FAQS

  12. Why DBS Vickers?

  13. Where Can I Learn More About Warrants?



What Is A Structured Warrant?

A structured warrant is issued by a third party financial institution, on the shares of an unrelated company, a basket of companies' shares or an index. It is a type of Option and listed in SGX.

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What Are the Types of Warrants?

Types Of Warrants Explanation
Call warrant A Call warrant gives the holder the right or choice to buy a given quantity of the underlying asset at a predetermined price (exercise or strike price), on or before the expiry date, depending on the exercise style of the warrant.
Put warrant A Put warrant gives the holder the right to sell a given quantity of the underlying asset at a predetermined price, on or before the expiry date, depending on the exercise style of the warrant.


Warrants have a fixed tenure and, if not exercised, are worthless after their expiry date.


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How To Read Warrants Symbols?

Example
Symbol of warrant with underlying share

Warrant Symbol 1

Symbol of warrant with underlying index

Warrant Symbol 2

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What Are The Features And Benefits Of Investing In Structured Warrants?

Feature Benefits
Gearing Structured warrants are usually priced at a fraction of the share price. This allows you to trade more warrants than the underlying share for the same investment outlay. Trading warrants therefore, offers benefits of gearing. For instance, a small percentage gain in the underlying share price may lead to a larger percentage gain in the value of the call warrants. Conversely, a fall in the price of the underlying share may lead to a larger percentage loss in the value of the warrants.
Unlimited upside but limited downside The maximum potential loss to you is the entire warrant price, which is usually a fraction of the share price. The potential gain of a warrant may be unlimited as it depends on the movements of the underlying share.
Protects the value A put warrant allows you to hedge against a fall in the price of a stock in your portfolio. You are therefore, assured of a minimum value equivalent to the exercise price for the stock in your portfolio.
Market Exposure Index and basket structured warrants with values linked to the performance of a benchmark index and pre-defined basket of shares respectively, will allow you to gain exposure to a sector or market. This eliminates the need of trading in a market portfolio of individual stocks.
Cash Extraction By selling existing shares and buying a corresponding number of warrants for a fraction of the share price, you are in fact releasing capital from holding shares and still maintain the same exposure.

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How Do I Exercise Structured Warrants?

Structured warrants listed in SGX are mostly cash settled automatically, i.e. there is no physical delivery of shares.

The procedures for the exercise of structured warrants are outlined in the Terms & Conditions of the warrants issue. Unless an automatic exercise is specified, this usually involves the submission of an exercise notice by the warrant holder to the warrant agent.

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What Are The Risks Involved?

Types Of Risk Explanation
Credit Risk Credit risk is the risk that the warrant issuer will not be able to fulfil its obligations. This occurs on the exercise of the warrant. Therefore, you should assess the credit risk associated with the warrant issuer.
Liquidity Risk Liquidity risk occurs when a warrant holder is unable to sell his warrant for a reasonable price in the market. This is due to insufficient buy orders which affects the market price of the warrant.
Market Risk Similar to other investments in the securities market, the market value of a warrant is susceptible to events that affect its demand and supply. Hence, the market value of your investment will fluctuate accordingly.
Default on market making obligation An issuer who has committed to make a market in a warrant issue may not fulfil its obligation due to unforeseen circumstances that may arise. Hence, you may experience liquidity risk despite a commitment from the issuer to make a market.
Limited life of warrants Warrants have a expiry date and therefore a limited life. A warrant may expire before your expectations are realised, making it worthless.
Extraordinary event The warrant issuer may declare a lapse of the warrant or bring forward the expiry date. This arises out of certain circumstances such as the delisting of the underlying asset. These circumstances are outlined in the Terms and Conditions of the warrant issue.

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How Are Warrants Priced?

The pricing of a warrant depends on a number of market factors. You should understand their relationship with the warrant price before investing. The price of a warrant comprises of two components - the intrinsic value and the time value.

Components Explanation
Intrinsic Value The Intrinsic Value of a warrant is equal to the positive difference between the strike price and the current price of the underlying, taking into the account the conversion ratio.
Time Value The Time Value is the difference between the current warrant price and its intrinsic value.

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What Are The Factors Affecting Warrant Prices?

  Call Put
Increase  Underlying Price Increase Decrease
Increase  Strike Price Decrease Increase
Increase  Volatility Increase Increase
Increase  Dividend Expectations Decrease Increase
Increase  Interest Rate Increase Decrease
Increase  Time to Expiry Increase Increase


Underlying Price :   The price of a warrant is derived from the related underlying asset price. A Call warrant is worth more as the underlying increases in value. Similarly, the value of a Put warrant will increase as the underlying decreases in value.

Strike Price :   A Call warrant with lower strike price is more likely to be exercised than one with a higher strike. Thus, a higher strike Call warrant is usually cheaper. Similarly, a Put warrant with a higher strike price is more likely to be exercised than one with a lower strike price, hence a higher strike Put warrant is more expensive.

Spot Level/Moneyness

Term Definition
In-the-money (ITM) For Call warrant, strike price is less than the underlying spot. For Put warrant, strike price is higher than underlying spot. Generally, there is a lesser proportion of the price in time value for ITM warrants.
At-the-money (ATM) Strike price is the same as underlying spot price. Time value is at its peak.
Out-of-the-money (OTM) For Call warrant, strike price is higher than the underlying spot. For Put warrant, strike price is less than the underlying spot. The warrant price is entirely made up of time value.

Time value erodes with time until warrant only contains intrinsic value on expiry.


Implied Volatility :   A measurement of the frequency and intensity of price change of underlying asset. A higher Implied Volatility implies higher warrant value.

Dividend Expectations :    Investors in warrants do not receive the dividends paid on the underlying shares, nor or do they directly participate in special dividends, rights or bonus issues. In valuing warrants, issuers estimate the expected dividend stream of the underlying shares. This means that Call warrants should not dramatically fall in price when the underlying share trades ex-dividend. Similarly, Put warrants should not substantially increase in price. Warrant prices can however be affected by a change to 'expected' dividends.

Generally, in the case of a special dividend, rights or bonus issue, the terms of the warrant are adjusted so that the investor is not disadvantaged.

Interest Rates :   For each Call warrant issued, issuers allocate funds to purchase underlying shares. If the cost of borrowing (ie. the interest rate) increases, the cost will be reflected in a corresponding increase in the warrant price. Similarly, a Put warrant will decrease in value when interest rates rise.

Time to Expiry :   The longer the time to expiry, the higher the probability that the underlying share price may move in favour of the warrant holder. Thus, a warrant with a longer time to expiry is usually more expensive.

Premiums :   The amount by which the cost of acquiring the underlying asset by exercising the warrant exceeds the cost of buying the underlying asset directly.

Call Premium =
((Warrant price x Conversion ratio) + Exercise prices) - Underlying share price
Underlying share price


Put Premium =
Underlying share price - (Exercise prices - (Warrant price x Conversion ratio))
Underlying share price


Breakeven Price :   Indicates the price level above (below) which the investor will make a profit in the case of a Call (Put) if it is held till expiry.

Breakeven price
Call =
(Warrant price x Conversion ratio) + Exercise prices

Put =
Exercise prices - (Warrant price x Conversion ratio)


Gearing :   Indicates the extent to which a warrant moves in line with its underlying. A higher gearing level means a higher potential profit or loss for the warrant holder.

Gearing =
Underlying share price
(Warrant price x Conversion ratio)


Delta :   is an indicator showing the absolute changes in the price of the warrant if the underlying share changes.

Delta =
(Change of the warrant price x Conversion ratio)
Change in the underlying share price


Effective gearing :   is a more accurate measure for warrant price movements. It indicates the percentage change in price of a warrant relative to one percentage movement in the underlying share price.

Effective Gearing =
Gearing x Delta

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A Case Study: How Do I Select A Warrant?

To select the warrant for your trading, here are some general guidelines:

No. Factors Explanation
1. Sector & Underlying Look at the sector and potential of the underlying share.
2. View Your view (positive or negative) on the stock will determine whether you select a Call or Put warrant.
3. Time Frame Your outlook of the underlying share whether it is short or long term plays a part in the selection. This is because of the time decay on warrant price.
4. Implied Volatility Usually, the higher the implied volatility, the higher is the value of the warrant. Hence, you should generally select warrants with lower implied volatility.
5. Magnitude You may wish to select a warrant with higher gearing if your outlook of the underlying share is very bullish. The larger magnitude of the share movement helps to compensate for the time decay.


View Short Term Long Term
Low Magnitude ST Expiry ATM LT Expiry ITM
High Magnitude ST Expiry OTM LT Expiry ATM

Money-ness:
OTM: ST and aggressive
ATM: Moderate outlook
ITM: LT and conservative

Example:
Choosing a Call warrant

Warrants Name Days to Expiry Strike Last % of Spot Gearing I.V. Volume Ent
COSCO CORP BNP ECW070330 143 1.75 0.375 0.8663 5.39 42.6 1,127 1
COSCO CORP CS EC070402 146 1.88 0.295 0.9307 6.85 42.09 800 1
COSCO CORP DB ECW070207 92 1.6 0.46 0.7921 4.39 44.91 13 1
COSCO CORP DB ECW070423 167 2.05 0.24 1.0149 8.42 44.51 170 1
COSCO CORP MBL ECW070402 146 1.9 0.28 0.9406 7.21 41.25 1,566 1
COSCO CORP ML ECW070418 162 1.85 0.33 0.9158 6.12 43.46 2,920 1

Source : www.warrants.com, 7 November 2006

COSCOCORPMBLeCW070402: ITM (6%), long expiry (conservative approach)
COSCOCORPDBeCW070423: OTM (1.5%)/ ATM, long expiry (aggressive approach)

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How Do I Read Warrants Expiry and Settlement?

Term Definition
Last Trading Day 4 Exchange business days immediately preceding expiry.
Last Market Making Day 5 Exchange business days immediately preceding expiry.
Cash Settlement European style, cash settled.
Final Settlement Price
(For shares as underlying)
Average of 5 day closing prices of underlying immediately preceding expiry. Will be adjusted for conversion.
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FAQS

How do I go about buying and selling Structured Warrants in the secondary market?
You may trade in Structured Warrants in the same way that you trade shares through your Trading Representative.


Can CPF funds be invested in Structured Warrants?
No. CPF fund cannot be used to invest in Structured Warrants.


Where can I get listed information / prices on Structured Warrants?
You may call your Trading Representative.


What happens upon expiry of the Structured Warrants?
Upon expiry if you are still holding the Structured Warrants, the Issuer will pay the relevant warrant holder the cash settlement amount, if any, in the settlement currency.


How is the settlement amount calculated for a cash-settled Structured Call Warrant upon expiry?
The settlement amount (positive) is the number of Structured Warrants multiplied by the difference of the Settlement Price and Strike Price.

Types Of Warrants Settlement Amount
Call warrant [(Settlement price - Strike price)/Conversion ratio] x no. of Warrants
Put warrant [(Strike price - Settlement price)/Conversion ratio] x no. of Warrants

Settlement Price is the arithmetic mean of the daily closing prices of the underlying on the 5 Exchange Business days preceding Expiry.


How do I exercise structured warrants?
Structured warrants listed in SGX are mostly cash settled automatically, i.e. there is no physical delivery of shares.


Can a Margin Trading account be used to buy Structured Warrants?
Yes. You may buy Structured Warrants with your Margin Trading account, but the Structured Warrant will have zero value if it is not in the Margin List.


What are the requirements of the underlying shares for the associated structured warrants to be listed?
The paid up capital of the listed company must be at least S$200 million or the market capitalization must be at least S$500 million over the past 30 days.


Will there be any adjustment for dividend payments?
There will be no adjustment to Structured Warrants in the event of dividend payment. Dividend payment is already one of the factors for pricing Structured Warrants.


How do I track my Structured Warrants investment?
You may call your Trading Representative.


Companies sometimes undertake capital increases/reductions, merge or change the nominal value of their shares. What happens to the Structured Warrants issued on such underlying assets?
In such cases, the issuer will make the necessary adjustments based on the terms and conditions of the Structured Warrant. Details of Adjustment may be found in the Structured Warrant Listing Document.

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Why DBS Vickers?

DBS Vickers Securities is one of the largest securities brokerages in Singapore and also one of the leading retail brokerages in Asia. In our constant effort to improve our service, we have now put in place the necessary infrastructure to enable investors to invest with just a phone call.

This improved accessibility will mean that investors may now just call their Trading Representatives in DBS Vickers Securities for their Warrants investment.

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Where Can I Learn More About Warrants?

Useful website:
www.sgx.com.

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Commission on Warrants
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