Covered Warrants I

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1. Introduction

Welcome to the world of covered warrants – the speed merchants of the stockmarket

The traditional company and investment trust warrants market seems sure to be eclipsed shortly in the UK by a new market which should offer huge opportunities for active investors. Revised regulations have paved the way for a new covered warrants market in London.

Whilst new ground is being broken in the UK, the market is following a path well trod by other countries. And unless Australian, Belgian, Dutch, Finnish, French, German, Hong Kong, Italian, Japanese, Portugese, South African, Swedish, and Swiss investors are all differently motivated from British investors, the market has a very strong chance of success.

There is a good reason why the more colourful exponents of the market use words like turbo, supercharged, race-tuned, supersonic and jet-propelled. Warrants are the speed merchants of the stockmarket. Equity warrants can produce tremendous gains in bullish market conditions, and covered warrants go one step better - they offer the thrill of big profits in all weathers.

Examples

Examples are not hard to find from overseas markets of large profits which have been made from underlying asset movements in either direction, and some of the gains are simply mouth-watering:

• Commerzbank Euro/US Dollar 09/02 0.95 currency call warrants translated a 13% increase in the euro over the last three months into a huge profit of 933% on the warrants
• Goldman Sachs S&P500 09/02 1000 put warrants converted a 27% drop in the market over three months into a 784% gain for the warrants
• BNP Paribas Deutsche Telekom 03/03 20 call warrants rose by 467% in response to an 18% rise in the share price over just one month
• SG Oracle 09/02 18 call warrants increased 115% after an 11% share price rise over the month
• JPMorgan Alitalia 09/02 0.703 put warrants which have flown up by 205% after the shares dropped by 24% over the month.

Risk

Covered warrants are exciting and have many advantages over other forms of investment. However, it must be said that the mechanics that allow for spectacular gains, can also allow spectacular losses. Price movements for warrants can be very large - and very quick. So, extra care is needed when trading these warrants. The purpose of this course is to give you a thorough understanding of the nature of these new instruments, and guidance in how to control the risk.

This course

This course is intended as a primer for investors new to covered warrants, although more experienced investors may also find some value in the timely information about the formation of the new market in London. Investors used to dealing in traditional listed warrants in the UK will find the new covered warrants quite different.

The course is split broadly into three parts:

1. Description of covered warrants and market characteristics
2. How to analyse warrants
3. Strategies for trading warrants

Note

Out of necessity the examples used in this book are from overseas covered warrant markets, because the UK market is not yet underway at the time of writing. There are some regional differences in the structure of warrants and in some terminology, and of course in local governing rules, but all covered warrants markets have much in common, and the comparisons are valid.

1. Introduction 2. What are covered warrants? 3. Comparison between corporate warrants and covered warrants 4. Advantages of warrants 5. Advantages of warrants – the magic of gearing 6. Disadvantages of warrants 7. Advantages & disadvantages - a summary 8. International warrants markets 9. UK warrant market 10. Types of covered warrant I (warrant terms) 11. Types of covered warrant II (underlying assets) 12. Types of covered warrant III (exotics) 13. Information on warrant terms 14. Warrant trading 15. Warrant pricing 16. Basic analysis I (underlying asset) 17. Basic analysis II (prices and terms) 18. Basic analysis III (gearing) 19. Basic analysis IV (intrinsic value) 20. Basic analysis V (premium) 21. Advanced analysis I (Black-Scholes Model) 22. Advanced analysis II (volatility) 23. Advanced analysis III (the greeks) 24. Risk 25. Trading strategies 26. Tax 27. Conclusion

• Andrew McHattie on Covered Warrants