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Trading Strategies |
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1. |
How can I limit my risk
exposure by buying a warrant? |
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If you want to gain an exposure on one
stock with very small outlay, you can use small part of
capital to buy a call warrant and putting the other into
bank. The type of structure has a capital protect effect
that is popular in the field of the structured product
market.
For example, the underlying stock is $50 per share
at current market level, and a six months maturity call
warrant of this stock, with strike $50, indicating at
$0.5 currently. The annual interest rate is 3%. Assume
the conversion ratio of this derivative warrant to stock
is 10:1. Assume the investment is $100,000.
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| Strategy A (stock): |
Purchase 2000 shares |
| Strategy B (warrant plus saving): |
Purchase 20,000 shares of the call warrant for
$10,000. Deposit the $90,000 in bank earning 3%
interest per annum. After six month the principal
and the interest will be: |
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$90,000 x (1+3% x 1/2) = $91,350 |
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Observation:
According to the above example, trading in warrants can
achieve: |
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Limiting the loss
Although the return on strategy B is lower than
that of strategy A, Strategy B can provide a downside
protection against unfavourable market movement. |
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Enhancing the flexibility
The method derived from strategy B can be used by
investors to develop their own investment portfolios
which is similar to some of the popular principal
guaranteed investment instruments. |
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Widening the investment opportunities
By using a relatively small amount of capital in
strategy B and diversifying the investment into
another financial instrument, an investor can maintain
the exposure on a specific stock as much as that
of strategy A. Investors can widen their investment
opportunities. |
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2. |
What is a more aggressive
approach to investing in warrant? |
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If you want to increase your participation
in the market when there is a clear market trend, a very
aggressive approach can be achieved by buying warrants
with the same amount of investment. However, the risk
that you have taken will be relatively high.
For example, an investor wants to leverage up the exposure
on a stock. The underlying stock of a call warrant is
$100 per share at current market level, and a three
months maturity call warrant of this stock, with strike
$100, indicating at $0.5 currently. Assume the conversion
ratio of this derivative warrant to stock is 10:1 and
the total investment is $100,000.
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| Strategy A (stock): |
Purchase 1000 shares |
| Strategy B (warrant): |
Purchase 200,000 shares of the call warrant with
strike $100. |
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Here shows you the possible payoff and rate
of return of two portfolios during these three months
investment: |
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Observation:
According to the above example, trading in warrant can
achieve:
The slope of payoff of Strategy B is much steeper than
Strategy A. It can be found that Strategy B is much
more sensitive to the change of price of the underlying
stock than Strategy A. This leverage effect can help
the investors increase their participation in bullish
market.
Conversely, if the value of underlying stock remains
unchanged until the warrant expire (on its initial value
$100). The value of Strategy B falls precipitously to
zero, the rate of return will equal to -100%.
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3. |
How can I protect my capital
against loss by using a warrant? |
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If purchasing stock seems risky to you,
you can try to use warrants to hedge the downside risk.
Combining the feature of warrant and stock, you can have
a better protection against adverse market situation.
It can provide you a good strategy when you have to keep
on holding the stock for reasons.
For example, if the market price of an stock is $25
per share, a six months maturity put warrant of this
stock, with strike $23, indicating at $0.10. You decide
to buy 4,000 shares of the stock with the total investment
in stock $100,000. Also, you buy 40,000 shares of the
put warrant.
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| Strategy A (stock): |
Purchase 4000 shares |
| Strategy B (stock + warrant): |
Purchase 4000 shares of underlying stock and 40,000
shares of put warrant for $4,000. |
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Here shows you possible payoff and rate
of return of two strategies during theses six months investment: |
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Observation:
According to the above example, trading in warrant can
achieve:
Put warrant can be used to hedge a long stock position
when the share price falls. The corresponding values
of a put warrant rises will offset the loss comes from
the stock. It can help investors preserve the value
of a portfolio in a bearish market or during an uncertain
period; investors then do not have to sell the shares
and miss a potential rally.
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Derivatives
