top of page

How people trade covered warrants (exchange listed)?

Writer's picture: Matthew CW WongMatthew CW Wong

Most retail investors in Hong Kong are familiar with covered warrants. Call warrants are call options and put warrants are put options. The word "warrants" describes the form of these options are securities from a warrant program where the issuer guarantees the terms and conditions of these warrants. In this article, we focus on some of the typical trading strategies or patterns by warrant investors.


Attracted by turnover. Investors consider high turnover as a reflection of popularity and perhaps a high chance of future stock movement. High turnover could also mean tight bid-ask spread and lower slippage in getting in and out. A key consideration in short-term trading, especially just holding the positions for seconds or minutes hoping to win a few ticks. The flip side is that some high turnover is generated by very few investors against the issuer who is market-making. The turnover could disappear suddenly and the bid-ask spread widens.


Look for low premium warrants. Some investors look for cheap leverage and indeed, for deep-in-the-money call warrant, the premium often looks cheaper than margin financing. Two reasons. Firstly, the issuer is a bank and their funding cost is interbank hence for deep in the money call, the premium could look attractive. Secondly, the call warrant holder does not get any dividend. Call warrants could trade at a discount because the issuer is willing to sell the call, buy the stocks to hedge, and receive the dividend.


Low price warrants. Typically out of money call warrant or warrants near expiry. In the case of out-of-money call warrants, the gearing is high and if the stock price drops, the call warrant could be worthless. As for warrants near expiry, it is either in the money or they expire worthlessly. It is almost like a gamble.


Relatively lower volatility. Some investors understand volatility and will choose the warrants of the same underlying with lower implied volatility. Please compare implied volatility with similar strike and maturity as different strikes could have very different implied volatility (the professional calls this skew) and different maturities/expiries also have different implied volatility (the term structure). Quite often, low implied volatility is due to a lot of profit-taking from existing holders or warrants that do not trade and the implied vol of the bid reflects where the issuer is willing to buy back.


Warrants are leverage and hence more volatile than the underlying stock. Call warrant holders do not get dividends and put warrant holders do not need to pay any dividend. So dividend is reflected in the pricing either based on assumption or announced dividend payment before the maturity of the warrants. If the underlying stock announces a dividend much higher than the issuer's assumption, the call warrant price would be negatively affected while the put warrant price should be positively affected. In case of a special cash dividend is declared, like 10% of the share price, the warrant issuer may have to adjust the strike and entitlement to reflect. Typically, follow the same adjustment as HKEx listed single stock options.


Hong Kong covered warrants are typically European cash-settled options. The cash-settled feature means the investor cannot get physical shares and cash-settled warrants will NOT be subject to stamp duty. European means no early exercise that simplifies the expiry and settlement arrangement.


4 views0 comments

Recent Posts

See All

Volatility, historical and implied

Simple option pricing models have a few parameters. They are call/put, strike, maturity, interest rate, dividend, and volatility. The...

Stock Options

The Stock Options market is often dominated by professional market makers and warrant issuers in terms of daily liquidity and open...

How people trade index options?

HKEx listed Index options Earning premium and sell options. Many option traders like selling options to receive a premium, and collect...

Comments


bottom of page