Warrants

Like an option, a warrant is a security that gives its holder the right to buy or sell a given quantity of an underlying asset at a pre-determined price, on or before an agreed expiry date. This means a warrant becomes worthless after its expiry date. The SGX has two types of listed warrants - traditional corporate warrants which have been around for many years, and the new structured warrants. While both these warrants may appear similar, many investors do not realise there are a number of major differences that affect their liquidity and market value.

As its name suggests, a corporate warrant is issued by a listed company, which makes use of its own shares as the underlying asset. Often, it is a sweetener during a fund raising exercise to entice shareholders to subscribe for a rights issue or bond issue. Corporate warrants typically have a lifespan of between three to five years. They can be exercised at any time before the expiry date into new shares, which will be issued and delivered by the company. While this helps bring additional funds into the company's coffers, the new shares created will cause earnings dilution for existing shareholders. A key distinction between a corporate warrant and a structured warrant is that the latter is issued by a third party, usually a bank or financial institution, on the existing shares of an unrelated company. As new shares are not created when these warrants are exercised, the company's shareholders will not have to be concerned with earnings dilution. Structured warrants also have a shorter lifespan, typically expiring within a period of two years.

Moreover, a company can only issue call warrants, meaning that holders can only exercise the right to buy the underlying shares. In contrast, a structured warrant can only be issued as either a call or put warrant. This is an important difference. As put warrants give holders the right to sell the underlying shares, there is flexibiliy for investors to take a trading position if they expect the share price to decline. In addition, put warrants also create opportunities for a wider range of hedging strategies, which we will discuss in more detail in future. As corporate warrants are usually issued to the company's shareholders during a fund raising exercise, they tend to be owned mainly by individuals and institutions. Due to their minimal cost, these warrants are usually tightly held which means there is restricted trading liquidity.

Structured warrants, on the other hand, are more market-driven products. To ensure a warrant is well traded when it is listed, the issuing institution has to tailor it to appeal to the needs of savvy private investors. The institution also has an oblighation to act as a market maker, which means it has to provide competitive bid and ask prices for the warrant. The ease of buying and selling structured warrants has made it an attractive choice for investors, as compared to corporate warrants. While this ready source of liquidity has been a big draw for the structured warrants market, another major reason for its success is the leverage these instrumnets provice investors to profit from movements in the underlying stock.

Source : Pulses, Aug 2007