It is wise to exercise caution when considering exotic warrant structures. The most important rule is as always to make sure you completely understand the product before you invest.
Barrier Warrants
One development of plain vanilla calls and puts is to add a price barrier to the terms. This style of warrant can also be called a capped warrant. The idea is that in addition to the usual terms including an exercise price and maturity, a barrier level is also incorporated, which can be high or low. Once the barrier price is hit, the warrant expires immediately, either providing a capped return, or in the case of knock out warrants, no return at all.
Call barrier warrants can be up and out warrants which may expire early if the asset level equals or exceeds an upper barrier level. In this circumstance a maximum return is payable. They can also be down and out, which means the warrants expire early if the asset level equals or falls below a lower barrier level. This can mean that the warrants will immediately expire worthless, or if the exercise price is below the barrier level, that a minimum payout is made. Put warrants can use similarly structured barriers.
There are also knock in barrier warrants where the breach of a barrier level causes a change in the terms of the warrants.
Barrier warrants are highly individual by nature, which is a good point at which to repeat the mantra that it is essential to check individual term sheets for precise details.
Corridor Warrants
Essentially, corridor warrants are designed to take advantage of times when investors believe an asset price will trade within a narrow band, remaining fairly static. They have in the past been called AIR corridor warrants – accrue income in range. The longer the asset stays within that band, or corridor, the more value is accrued and the more the warrant is worth. Usually a set payment will be made for each day the asset value stays within the specified band, up to a final maturity date. Effectively these are a development of barrier warrants – in this case there is both an upper and a lower barrier.
Example
SG Dow Jones Corridor Warrants; spot index level 10,200
First listed September 10th 2001 in Amsterdam
Tranche A: corridor 9500-11,500; issue price EU4.08; pay out EU0.05 per day in range; maturity 04/02/02
Tranche B: corridor 10,000-11,000; issue price EU2.77; pay out EU0.05 per day in range; maturity 04/02/02
Trigger Warrants
Trigger warrants are not common, but they are possible. These warrants specify a particular event in their terms, such as the underlying asset reaching a specified level. If the trigger event occurs then a fixed payout is made; and if not the warrant expires worthless. These ‘all-or-nothing’ warrants have a lot in common with a straightforward wager. Warrant analysts will not generally encourage comparisons with horse racing, or with Russian roulette, but in this case they might not be entirely without validity.
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