Traditional corporate equity warrants

1  2  3  4  5  6  7  8  9  10  11  12  13  14  15  16  17  18  19  20   

5. Further attractions of warrants

Hedging

Although warrants are more volatile than shares, there are strategies involving warrants that can reduce the risk of owning shares. [We'll talk about these in more detail later in the course]. Briefly, switching an investment from shares into a combination of warrants and cash, maintains upside exposure to the company, but reduces the downside risk as a significant part of the total investment is now in cash - not at risk to the equity market.

Inefficient market

The warrant market can be very inefficient. This can be frustrating for some investors, but for others it's a fertile fishing ground for opportunities.

Lack of research

Related to the point above, there is not much research on the warrant market. But where would you expect to find more misevaluation opportunities - in a FTSE100 stock like Vodafone (which has tens of analysts and thousands of investors following it closely), or a small warrant issue, with awkward terms and whose price isn't quoted in the FT?

Well-suited for private investors

Although we are commonly told that the internet has leveled the investing playing field, it is still the case that institutional investors have overwhelming advantages over individual investors in almost all areas of investment. Except warrants. The poor liquidity (e.g. the smallness of many warrant issues) precludes almost all large fund managers from getting involved in the warrant market. This leaves the whole market largely to individual investors where they can have a real impact. They do not have to suffer the 'market manipulation' of large institutions.

Tax

The advantage here is simplicity. Warrants pay no income, so their sole return is capital gain, and thus liable only to the reasonably straightforward rules of Capital Gains Tax (CGT).

As a side note, warrants are sometimes said to be especially good for children! Normally, high-risk instruments, such as warrants, are said to be inappropriate for widows and orphans. However, the taxation situation of children is rather particular. Children benefit from having a full CGT allowance, but any income they earn is added to that of their parents.

1. Introduction 2. What is a warrant? 3. The warrant market 4. Advantages of warrants over shares - the magic of gearing 5. Further attractions of warrants 6. Disadvantages of warrants 7. Fundamentals - warrant terms 8. Fundamentals - intrinsic value and parity ratio 9. Basic analysis 10. Analysis - time value and premium 11. Analysis - gearing 12. Analysis - break-even and capital fulcrum point 13. Analysis -sample spreadsheets 14. Analysis - summary 15. Investing strategies 16. Dealing in warrants 17. Warrant exercise 18. Further topics 19. Further information 20. Conclusion

• Andrew McHattie on Covered Warrants