You need your brain switched on when dealing in covered warrants - or to delegate the brainwork to someone else. They are not as simple as shares, or even as traditional warrants, and they can get confusing at times. When you buy a share you are buying a slice of a company, which is an easy concept to understand. Derivatives are by their nature less straightforward, deriving their value from another instrument and therefore being one extra step away from the profits, assets, and true value of a company.
If you have read some guides, and this course, and just don't feel able to grasp the fundamentals of warrant investing, then the best thing to do is to walk away. You should not invest in anything you do not understand, no matter how attractive it might seem on the surface.
Adverse price movements
Warrants will not generally whip the shirt off your back quite as quickly as a casino croupier, but as geared instruments they have the capacity for very quick and dramatic price movements which can easily catch you out if they go the wrong way.
A small change in the price of an underlying asset, or perhaps no change at all, can lead to a substantial decline in the value of covered warrants. Market timing can be very important, and if you get it wrong then the results can quickly become painful. Warrants are by no means buy-and-forget instruments. When things go wrong the performance can turn very nasty very quickly, and the result can be a total loss of the money invested.
Premium
There is a price to pay for the many advantages which covered warrants confer, and that price is the premium. This is the extra amount in the warrant price beyond the value which it would have if it were to be exercised immediately, and the premiums can on occasions be very high.
Limited life
Many investors have a few stale long-term holdings in their portfolios which were once-great ideas which did not quite work out. With shares, unless the company actually goes bust, there is always the option to hold for the long-term and to hope for the best. Because covered warrants have a finite defined life, this possibility is removed. In many cases warrants will be issued with a life of just one year, and at the end of that year, the warrant will expire, either with some intrinsic value, or no value at all.
For this reason covered warrants are often approached with a trading mentality, and many investors enjoy the cut-and-thrust of regular dealing which is made possible by the excellent liquidity and dealing spreads. For long-term investors though, individual covered warrants are generally unsuitable as they do not offer much in the way of longevity.
Time value decay
Premium (or time value), disappears as warrants approach their final expiry date, which means that if the underlying asset stands still, the associated warrants will fall in value, whether they are calls or puts. Dull markets are not welcome. This in-built requirement for the underlying asset to move in the right direction is a drawback, as is the slow drip of the time value disappearing.
Absence of price anomalies
Traders in the traditional equity warrants market can sometimes enjoy the fact that the market is small, overlooked, and illiquid. These features mean that price movements are far from uniform and that anomalies frequently arise.
The pricing system for covered warrants, where supply and demand are less important factors, means that anomalies, price dislocations, and stickiness will seldom arise. This is a pity in some respects, but it should be noted that the price anomalies in the equity warrant market only arise because of the illiquidity, which can be a high price to pay.
No Income
Normal trading warrants do not rank for any income. They do not qualify for dividends paid on underlying shares, which in the case of higher yielding assets can be a considerable drawback. Most covered warrants are pure capital instruments, although this is not true for some of the �investment� variants which have been developed, such as instalment warrants in Australia.
If you do require income from your securities investments then you will need to consider what proportion of your portfolio might be allocated to warrants, if any.
No shareholders� rights
The value of a warrant may be based on a company�s shares, but as covered warrant holders are not linked directly to that company, they rank for none of the rights which shareholders enjoy. Covered warrant holders have no voting rights, will not receive annual or interim reports, and will not qualify for any shareholders� perks which may be on offer.
Need to have online access
Covered warrants are complex, which means there is a need to disseminate a lot of information � not just the price. It is difficult to perceive how this could be done through traditional print media, and the issuers are certainly set up to deliver a range of services and information electronically.
A considerable bulk of information will be on the internet, and the internet only. This is partly a practical matter � just consider the amount of space required otherwise to provide a decent amount of information on the new issues. On a busy day in Germany 200 new warrants can be issued, all with detailed term sheets.
If you do not have internet access, or at least access to e-mail, you may be at a considerable disadvantage. It will not preclude you from participating in the new market by any means, but there might be a constant nagging doubt as to whether you are really as informed as you could be.
Capital Gains Tax
The taxation position of covered warrants appears on both sides of this chapter. The absence of stamp duty is an advantage over shares, but the imposition of capital gains tax (CGT) is a disadvantage when covered warrants are compared with one of their closest rivals: spread-betting. Covered warrants, as securities, will be treated by HMRC in the same way as shares as far as CGT is concerned.
Individual warrants do not at present qualify for inclusion in an ISA, although an authorised warrant fund may be eligible.
Credit risk
When you buy a covered warrant, you are doing so on the understanding that the issuer will honour its terms and provide the relevant payout at the end of its term. The issuer is your market counterparty. There is a (seemingly very small) risk of an issuer defaulting and failing to keep up its end of the deal.
Whilst this is unlikely to occur, given the regulatory requirements for the financial strength of the banks authorised to issue warrants, investors have learned never to say never.
Recommend ReadingBook offers!
|
|
Building Automated Trading Systems
Benjamin Van Vliet |
| Our price: £36.00
Normally: £45.00 |
|
|
Reminiscences of a Stock Operator
Edwin Lefevre |
| Our price: £9.09
Normally: £12.99 |
|
|
Mergers, Acquisitions, and Other Restructuring Activities
Donald DePamphilis |
| Our price: £46.39
Normally: £57.99 |
