A Structured Warrant (SW) is a security that gives the holder the right but not the obligation to buy or sell a specific underlying asset at an agreed price (strike price) on the expiry date. As an investment tool, it provides investors’ exposure to an underlying asset for a fraction of the price. On the Bursa Malaysia, warrants are currently available over shares and indices.

• Call Warrants: if the settlement price of the underlying is above the strike price at expiry, the call warrant is deemed to be “in-the-money” and the holder will receive a cash payment. Otherwise the warrant will expire worthless.
  
  
• Put Warrants: if the settlement price of the underlying is below the strike price at expiry, the put warrant is deemed to be “in-the-money” and the holder will receive a cash payment. Otherwise the warrant will expire worthless.

• Single stock warrants: for warrants over shares, the settlement price of a Macquarie warrant is calculated by using the average closing price of the shares for the five (5) Market Days prior to the expiry date.
  
  
• Index warrants: for warrants over indices, the settlement price of a warrant is calculated by using the final settlement price of the relevant spot-month index futures contract on the expiry date.

Company warrants are call warrants issued by companies (with their own stock as the underlying) for the purpose of raising capital. There are no designated market makers for company warrants, and they are typically only suitable for longer term investment as liquidity is uncertain. They are often held until expiry.

SW are an investment tool issued by third-party financial instituitions (issuers) who are obliged to make continuous bid/offer prices in the warrant to ensure liquidity (i.e. To “make markets”). They are designed specifically as a short term investment tool and are usually not held to expiry.

No, warrants are not a ‘zero sum game’. The aim of the issuer is to make a profit on the risk management of the warrants sold, in doing so they also take on risk. When issuers sell warrants, they will normally buy shares or other derivatives to ‘hedge’ their positions and attempt to capture a margin whether the share price goes up or down.

For example, when an issuer sells a call warrant they will usually go into the underlying market and buy the shares to hedge themselves. Thus, if the share price increases, and investors profit on their call warrants, the issuer will also gain on their shareholding.

It is a common misunderstanding that issuers want investors to lose money. In fact, it is quite the opposite. If investors lose money, they will likely not trade warrants again, whereas if they profit from trading warrants they are more likely to continue trading and the market will grow.

Every warrant issuer must appoint a market maker (MM). It is the MM’s role to provide continuous bid and offer prices in the warrant so that there is sufficient liquidity for investors to enter and exit their trade. The MM will also assist in price discovery, and will often be the primary influence in determining the market price for the warrant.

If an issuer is providing ‘active’ market making in a warrant, it means that they are keeping a tight bid and offer spread with the aim of selling this warrant to investors. There are situations however, where an issuer may not be keen (or able) to sell a particular warrant. For example, if the issuer has already sold a large number of warrants in a particular underlying and their risk position is large, they may widen the offer spread to discourage further selling to investors. Similarly, if an issuer sells out of their warrant inventory, they may not be able to sell any more warrants.

Macquarie always widens the offer spread in such situations, so that existing holders can still sell at a fair price. However, in such instances, other investors may bid above the market maker’s bid price, thereby increasing the warrant price and making it appear as though it is on a tight spread. Investors who buy such warrants are taking a high risk, as these ‘other investors’ may not be there when they want to sell the warrant, and the price may therefore fall to meet the market makers bid.

As orders on the Bursa Malaysia are anonymous, the only way to determine whether a market maker is on a tight spread is to get this information from the market maker directly. Macquarie are currently the only issuer in Malaysia that provide a “Live price matrix”. The Live matrix has a direct feed to the market making trading system, meaning investors can see exactly which prices the warrant will be bid and offered for each corresponding level in the underlying. Therefore, it is easy to see if the issuer is on a tight or a wide spread.

There are a number of factors that can affect the price of a warrant. Other than the underlying price and market demand/supply, the price of a warrant may also be affected by factors like implied volatility, time to maturity and foreign exchange rates, among other things.

Macquarie always widens the offer spread in such situations, so that existing holders can still sell at a fair price. However, in such instances, other investors may bid above the market maker’s bid price, thereby increasing the warrant price and making it appear as though it is on a tight spread. Investors who buy such warrants are taking a high risk, as these ‘other investors’ may not be there when they want to sell the warrant, and the price may therefore fall to meet the market makers bid. Typically, when an underlying share or index moves and the warrant price does not move accordingly, it may be due to:

• Low delta – When a warrant’s exercise price is a long way from the underlying price, the warrant is deemed to be “deep out-of-the-money” and has a low delta. Meaning it requires a large movements in the underlying to change the price of the warrant.
  
  
• Time decay – The warrant price will slowly decay in value as it approaches maturity. If you hold the warrant for a period of time, this decay may offset some or all of the gain caused by a movement in the underlying.
  
  
• Implied volatility (“IV”) – Changes in IV may affect the price of a warrant. A rise in IV will increase the price of a warrant, whereas a fall in IV will cause a warrant price to fall.
  
  
• Conversion ratios - If a warrant has a high conversion ratio it will tend to be less responsive to movements in the underlying (than a similar warrant with a lower conversion ratio).
  
  
• Exchange rates - Foreign index warrants will be effected by relevant exchange rate. A change in the exchange rate can either increase or decrease the price of a warrant.

It is also very important to understand how to track a warrant price over time. Many investors are confused about how to accurately compare a warrant price change with changes in the underlying, leading to some misunderstanding.

You can learn more about warrants from Macquarie’s warrant website at www.malaysiawarrants.com.my

Price changes in listed securities are commonly published on a “daily price change” basis, which are derived using the difference between the current traded price and the closing price of the previous day. However, using this same method to track the performance of a warrant is often inaccurate, as warrants do not trade as often as shares. The previous closing price for a warrant may relate to a trade done the previous morning, or even days or weeks ago.

The best way to track the performance of a warrant is to look at the change in its bid price over the period, and compare this to the price change in the underlying stock (over the same corresponding period of time). The warrant bid price is the price at which investors can sell their warrant and thus is the best reference for the value of a warrant at any point in time.

Investors can use the “Warrant Charts” function under “tools & Charts” at www.malaysiawarrants.com.my to see how a warrant’s bid price has changed over time, along with the underlying share price or index.

The live matrix has a direct feed to Macquarie’s market making system, showing investors exactly where the market maker’s current bid and offer price in the warrant will be, for various levels in the stock.

The live matrix is a very useful tool for two reasons. Firstly, it allows investors to see how the warrant price will move in line with movements in the underlying stock or index, providing transparency and also better understanding. Secondly, it allows investors to see whether Macquarie is maintaining a tight spread in our bid and offer quotes.

There are a few instances where a market maker may widen their spread for a warrant, such as when the delta of the warrant becomes very high or low, or when the issuer sells out of inventory. Investors should take great caution when buying warrants that are on a wide spread, however this is not always visible as other investors’ orders can make the warrant appear as if it is on a tight spread. Now with the live matrix, investors can see exactly where Macquarie’s bid and offer prices are and whether we are keeping tight spreads.

The exercise ratio is the number of warrants needed to exchange for one underlying share or index futures at expiry. The sole purpose of the exercise ratio is to break down the warrant into smaller units, so a warrant which is priced at RM1.00 would then be worth RM0.50 with an exercise ratio of 2.

The sensitivity of a warrant price to the changes in the underlying price can be estimated by “delta per warrant”.

A warrant with smaller exercise ratio is more expensive, but will have higher delta per warrant. While a warrant with higher exercise ratio is cheaper but will have lower delta per warrant. If all else is equal, both warrants would give you the same return in percentage terms. Therefore, the exercise ratio should not be a major differentiating factor in the process of choosing a warrant.

The implied volatility (“IV”) for a warrant reflects the comparative price versus other similar warrants. You can compare the IV of a warrant against similar warrants over the same underlying only. If the warrant in question has a much higher IV than others, it may be that this warrant is relatively overpriced.

Sometimes the IV of a warrant can change and effect the warrant price. This is usually due to the supply/demand for the warrant, or because there is a change in the volatility of the underlying share or index. An increase in IV will cause an increase in the warrant price, where a fall will cause the warrant price to decrease.

No, a warrant’s liquidity is not calculated in the same way as it is for stocks. You can’t simply look at the recent traded volume. In fact, a SW can have no volume traded at all and still be highly liquid. This is because of the existence of market makers, who provide bid and offer prices, and typically contribute the majority of the liquidity in a warrant.

The liquidity of a warrant is primarily determined by two factors: the liquidity in the underlying stock, and the quality of the market maker. If the underlying stock is highly liquid, the market maker will typically provide larger volumes on the bid and offer of the SW, which will translate into more liquidity for the SW itself. However, it also depends on the quality of market maker. Most market makers use a computer trading system to provide bid and offer prices. The more sophisticated the trading system and the more experienced the market maker, the more liquidity they’re normally able to provide in their warrants. The easiest way to determine which market makers provide greater liquidity is to compare the bid and offer volumes of their warrants. The warrants with the larger bid and offer volumes are typically the most liquid.

If a warrant is "in-the-money" at expiration, the holder will receive a cash payment of an amount equal to the difference between underlying price and exercise price (multiplied by the conversion ratio) within 5 working days after expiry date.

Put warrants allow investors to profit from downward moves in the underlying share or index. Meaning, put warrants can be used as a form of insurance to protect an existing shareholding or portfolio against a falling market. This is called “hedging”.

The owner of a particular share could hedge against market uncertainty by buying a corresponding put warrant. In case where the share price falls, the profit made from the put warrant can then be used to offset the losses from the share. This way, investors can retain share ownership while at the same time protecting themselves against short term falls in price.

More commonly, investors tend to use index warrants to hedge their portfolio. For example, if an investor owns a portfolio of Malaysian equities, they might buy a FBMKLCI put warrant to hedge their position. If the market falls, the gain on the put should offset some of the losses on their equity position. However investors need to be aware that their portfolio may not be correlated to the FBMKLCI index, so the hedge is not likely to be perfect, and in some cases may be ineffective. Say for example if their shares fall by more than the index, the hedge will not fully offset their losses.

Every SW has a designated market maker that provides competitive buy and sell quotes on behalf of the warrant issuer. It is important to choose a high quality and reputable warrant issuer that provides consistent and competitive bid-offer quotes so that investors can easily enter and exit their trades.

Investors should also consider the credit rating of the issuer, as they would be exposed to losses if the issuer were unable to fulfil their obligations.

Macquarie is the leading issuer in Asia with the largest market share in Singapore and Malaysia, and a leading position in Thailand and Hong Kong. We proudly attribute much of our success to our commitment to providing high quality market making for investors.