Warrants
Overview
This module aims to offer insight into warrants – what they are and the two main categories of warrants.
It will also explain who warrants are for and their main features.
Defining Warrants
Warrants are financial instruments that give investors the right, but not obligation, to buy (Call Warrants) or sell (Put Warrants) an underlying asset, at an agreed price (the strike price), on or before an agreed expiry date.
The underlying assets can be Shares, Indices, Commodities or Currencies. Warrants are traded on the JSE’s Equity Market and issued by companies. Warrants differ from each other in terms of the type of their underlying asset or limits and the strike price at which the Warrant can be bought or sold.
Call Warrants
Warrants can be classified into 2 categories - Call Warrant and Put Warrant:
Call warrant gives the holder the option to purchase an underlying security at an agreed price.
For example: If an investor believes that the price of Share A will increase they will buy a call warrant that allows them to purchase Share A at the strike price R100. If in future the price rises to R120 the warrants holder can exercise the right to purchase Share A at R100.
Put Warrants
Put warrant gives the holder the option to sell an underlying security at an agreed price.
For example: If an investor believes that the price of Share A will decrease they will buy a put warrant that allows them to sell Share B at the strike price R90. If in future the price drops to R80 the warrants holder can exercise the right to sell Share B at R90.
Types of Warrants
There are several types of warrants:
- Single Equity Warrants (Vanilla Warrants)
They allow investors to buy (call) or sell (put) an underlying share at a predetermined price on or before a specified date. - Basket Warrants
- Basket Warrants are very similar to Vanilla Warrants except that the underlying asset consists of shares from a group of different companies. The companies concerned often carry out similar activities, for instance mining or transportation.
- Barrier Warrants
Barrier Warrants are similar to Vanilla Warrants except that they have a barrier level. If the price of the underlying asset breaks this level, the warrant becomes worthless and holds no further rights to the holder of the warrant. - Bond Warrants
Bond Warrants are very similar to Vanilla Warrants except that the underlying asset is not a share, but a bond. - Index Warrants
Index Warrants are very similar to Vanilla Warrants except that the underlying asset is not a share but an Index. An Index Warrant is settled by cash payment, calculated using an index multiplier assigned by the issuer when the warrant is first issued. - Discount Warrants
Discount Warrants allow investors to gain exposure to an underlying asset at a lower cost than that of Vanilla Warrants. Investors are able to pay less for these warrants because, with Discount Warrants, the potential profit is limited compared with that of the more conventional Call and Put Warrants. - Capital Protection Warrants
Capital Protection Warrants give the holder a guaranteed return. These warrants are in essence a combination of warrants (Single Equity warrants, Index Warrants and so on) and a risk-free investment. - Currency Reference Warrants
Currency Reference warrants give the holder exposure to the underlying exchange rate. - Commodity Reference Warrants
Commodity Reference Warrants give the holder exposure to price movements in the underlying commodity. - Reset Warrants
Reset Warrants differ from Vanilla Warrants in that they have a pre-determined reset date on which the strike price of the warrant could be changed in the investor’s favour. This increases the probability of the warrant ending in the money and effectively gives the investor a second chance when an anticipated move in the underlying asset does not occur as initially expected. After the reset date, Reset Warrants behave like Vanilla Warrants.
Who are Warrants For?
Investors wanting to gain geared exposure to the price movements of underlying assets invest using warrants.
Investors wanting to protect existing portfolios against adverse price movements can use Call Warrants when they believe the price of an underlying asset will increase, and Put Warrants when they believe it will decrease.
Features of Warrants
Warrants have the following features:
- Allow investors to benefit, whether asset prices are climbing or falling.
- The most an investor can lose from investing in a warrant is the initial price paid for the warrant.
- Warrants give investors exposure to a wide variety of asset classes.
- Warrants are highly liquid.
- Buying a warrant from a particular issuer implies that you are taking on the credit risk of that issuer.
- The prices of warrants move with those of the underlying assets and are subject to market risk because of social and economic unpredictability.
- The value of warrants can be more volatile than the value of the underlying share.
To invest using warrants, you can open a brokerage account with a JSE Equity Market member.
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