Covered Warrants I

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2. What are covered warrants?

Let’s take this gently…

Definition

It’s a good idea to treat the process of warrant definition as a glass of fine wine. Swallowing the whole lot in one great gulp can make you dizzy. It is better to sip. There is a lot to savour. Not only are warrants composed of a number of elements, but those elements vary markedly between differing forms of warrants, of which there is a broad array. And just as different wines are suitable for different drinkers, different tables, and different budgets, covered warrants offer equal diversity. There are:

• call warrants and put warrants
• American-style warrants and European-style warrants
• vanilla warrants and exotic warrants
• stock warrants and index warrants
• instalment warrants and basket warrants
• currency warrants and commodity warrants
• in-the-money and out-of-the-money warrants
• cash-settled and stock-settled warrants.

More simply, then,

a warrant is a right to buy or sell an asset at a fixed price, on or before a specified future date.

Warrants are similar to options. They present opportunities for capital gains which make them an attractive medium for speculative investing, although they can be used to serve a variety of aims.

The attraction of warrants

As mentioned already, there are many different types of warrants, but the common theme is that they enable investors to obtain exposure to the performance of the asset for a fraction of the price. This is called gearing. Instead of paying 100p for a share, warrants might provide the same profit potential for 20p, and this lower price means that their percentage gains (or losses) are greater. Gearing means that you get more bang for your buck.

Example

As always, the best way to describe covered warrants is by way of an example -

In the above case, a 30% increase in the share, results in a 300% increase in the warrant – this is the effect of gearing.

And an advantage of covered warrants over traditional UK warrants, is that money can be made in a falling market by buying put warrants. Another example -

Note: We've highlighted above the main attraction of warrants, which is the gearing effect on performance. Remember, though, this gearing works both ways: it propels warrant prices up quickly, and can do the same driving them down.

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