Since Malaysia's first warrant appeared in 1990, this derivative
has gained popularity. The following is only a brief guide on trading
in warrants. Subscribers of i Capital® are encouraged to conduct
their own research to fully understand this volatile investment.
What is a warrant?
A warrant is a right to buy a share of a firm at a certain price
during a given time period. A warrant can be exercised ( converted
to an ordinary share ) at any point within this given time period.
Why does a company issue warrants?
Warrants are often offered as "sweeteners" in a loan stock/bond/rights
issue. In the case of a bond/loan stock issue, a warrant may give
the company a lower interest payable on the issued debt.
How do you put a price on a warrant?
A warrant has 2 values : intrinsic value and time value. Its intrinsic
value is the difference between the current price of the underlying
stock and the warrant's exercise price. Factors that positively
affect a warrant's time value are the expected volatility of the
underlying stock and the warrant's time to expiration. Other factors
to be taken into account are expected dividends from the underlying
equity and market sentiment.
Ratios and pricing models.
Ratios help investors judge if a warrant is priced fairly. By looking
at them, investors are able to value a warrant relative to its historical
pattern and other warrants. Common ratios used are: premium, gearing,
parity and equity appreciation to double warrant. Pricing model
put a theoretical value on a warrant, taking into account factors
such as the volatility of the underlying share and many others.
Two popular pricing models are the Black - Scholes and Binomial
option pricing theory. These models are dependent on the efficiency
of the market to reflect their underlying assumptions; hence they
may not be precise when estimating the price of a warrant on the
Relationship between a warrant and its stock
Where the issuance of warrants in itself does not change the value
of the firm, the issuance of warrants does have a direct effect
on the share price of the firm. This relationship can be shown with
the following equation:-
P = PX - qW
P = the new price of the share
W = the value of the warrant
q = number of warrants / number of shares
PX = the old price of the share
Should I buy warrants?
Two factors should be considered before purchasing warrants. First,
the investor must be confident of the underlying share. Secondly,
the warrant must be attractively priced based on relative valuation
( ratios ) and / or pricing model.
Market Price of Equity $5.55 (A)
Market Price of Warrant $2.83 (B)
Exercise Price of Warrants $3.80 (C)
Equivalent Price $6.63 (B + C)
Parity Ratio 1.46 (A / C)
Premium 19.46% [(B+C)/A]
-1Gearing 1.96 (A/B)
Equity Appreciation to Double warrant 70.45% [(2B+C)/A]-1
Once the above 2 factors have been taken into account, an investor
might decide to purchase warrants to maximize his / her return from
the equity market. Warrants are the best instrument to maximize
gain when an investor is very bullish. They give investors a chance
to participate in the movements of shares at a lower capital cost.
However, the market for warrants is still small, hence warrants
may be volatile and may be the target for artificial rallies. So
buy warrants only if you like the underlying share and the warrant
is fairly priced according to the ratios and pricing theories mentioned