Myth 1: Warrant Investment is a zero-sum game - Issuers are betting against warrant investors
- Investors make profits from warrants by getting their direction on the underlying asset right. When issuers issue warrants, they will neutralise or hedge the risk arising from the warrants sold through various means including buing options in the OTC market or purchasing the underlying assets itself.
- Any gains or losses in the warrant price due to movements in the underlying asset will be offset by a change in the price of the hedging instruments. Hence, issuers will not suffer losses if investors make profits - they are not betting against each other in a Zero-Sum Game.
Myth 2: Issuers hope that the price of the underlying asset goes down (for call warrants) or up (for put warrants) so they can earn the entire issue price
- When warrant issuers issue warrants, they do not take a view on the future direction of the underlying asset but instead adopt a neutral stance. Issuers charge a fee for issuing warrants which is included in the price of the warrants that investors pay when they buy the warrants.
- Proceeds from the sale of the warrant are also used to cover various expences that issuers incur. These include issuance costs (e.g. legal fees, listing fees, license fees), hedging costs etc.
Myth 3: Issuers issue warrants to dispose shares they own
- If issuers need to dispose shares, they can do so directly in the market like any investor.
- There is no added incentive for issuers to dispose shares through the listing of structured warrants as costs are incurred for every new issuance of a warrant.
Myth 4: Issuers issue warrants with high exercise price so that they can cash out at a good price
- There is a trade off between the exercise price and issue price. The higher the exercise price, the lower [higher] will be the price of the call [put] warrant, and vice versa.
Myth 5: Warrant issuers will influence settlement prices by manipulating the price of underlying assets
- SGX-ST listing requirements stipulate that the settlement price of a stock warrant shall be determined based on the average of the closing prices of the underlying stock over five market days prior to expiry.
- Warrants are frequently purchased by investors for trading purposes and seldom held to expiry. Hence, the outstanding warrants held by investors on expiry are often small. This, coupled with the listing requirements on settlement price determination, makes it difficult for issuers to manipulate the prices of underlying assets.
Myths 6: Warrants are illiquid products
- Under SGX-ST listing rules, warrant issuers must appoint a DMM to provide competitive bid and offer quotes on a continuous basis if the issuers do not satisfy the minimum placement requirements. DMMs are also required to specify in the listing documents of their warrants, the maximum spread between the bid and offer quotes and minimum lot size which they must adhere to.
- These rulings are present to ensure that the structured warrants maket has adequate liquidity so that warrant holders can buy and sell their warrants with little difficulty under normal conditions.
Myth 7: Warrants with high turnover or large outstanding quantities are good picks.
- High turnover or large outstanding quantity (warrants sold into the market) should not be important factors in selecting which warrants to trade or invest in nor should they be regarded as indicators that the price of the warrants will rise in the future.
- If a large percentage of a particular warrant issue has been sold into the market, the price of the warrant may be influenced by strong interaction between market forces, i.e. changes in demand and supply. When this happens, the market price of the warrant may not reflect its fair value temporarily.
Myth 8: Warrants that are very low in price are attractive to trade
- These are often deep out-of-the-money warrants with short lifespan. Such warrants are not suitable for short-term trading as they are less responsive to price movements in the underlying asset and have low probability of expiring In-The-Money. In addition, these warrants will experience a higher rate of time decay and may decline in value even if the price of the underlying asset moves in a favourable direction.
- Hence, deep out-of-the-money warrants are high risk warrants.