Structured Warrants on SGX

Warrants are traded on the Singapore Exchange (SGX) just like stocks, but how much do we really know about them? This is the first of a three-part series on CashBench that points out the key features of warrants and summarises all the important aspects that an investor MUST know before investing in warrants.

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What are Warrants:

Despite being traded like stocks, warrants are a form of derivative products such as futures and extended settlement contracts. As a derivative, the price of a warrant depends on a number of factors that are linked directly or indirectly to the price of an underlying asset. On the Singapore Exchange, the underlying asset of a warrant is usually a stock index (e.g. STI, Hang Seng, Nikkei 225, etc) or one of the larger companies listed on SGX (e.g. Capitaland, Cosco, DBS, etc). Outside Singapore, the underlying asset can be currencies, bonds, commodities or just about anything else that has a price attached to it. Investors who are very keen on warrants may eventually invest via Hong Kong as well since it has a larger market with more warrants to choose from.

Forms of Warrants:

Of the 3 forms, the structured warrant is the most common form in Singapore and will be the focus of this three-part series on warrants.

There are at least 3 forms of warrants available in Singapore, including company warrants, structured warrants and investment warrants. Company warrants are issued by a listed company that may be exchanged for new shares if the company’s share price reaches a pre-determined level. Structured warrants (also known as Covered warrants) and Investment warrants are issued by unrelated third-party banks such as Societe Generale, Macquarie or Deutsche Bank. Investors of structured warrants are not entitled to any stock dividends declared by an underlying company, unlike investment warrants. Of the 3 forms, the structured warrant is the most common form in Singapore and will be the focus of this three-part series on warrants.

Basics of Warrants:

Warrants come in 2 types, Call warrants and Put warrants. Both types will always have an exercise price (also known as strike price) which is used to determine if we have the right to buy or sell the underlying asset. How about an example? Let’s say we have bought a warrant with an exercise price of $15 and the underlying asset is DBS shares. With a call warrant, we will have the right to exercise the warrant and buy DBS shares at $15 if the share price of DBS moves to $15 or higher. On the other hand, a put warrant gives us the right to sell DBS shares at $15 if its share price becomes $15 or lower. In either scenario, we have benefited from a favourable movement of the underlying share price.

An even more specific example? Let’s say the share price of DBS climbed to $20 and we are still holding on to the DBS call warrant with a $15 exercise price. For every DBS share that we can buy through the warrant, we gain $5! Why? Simply because we are now entitled to buy DBS shares at $15 even though the market price for these shares is much higher at $20. If we can exercise our right and sell the DBS shares immediately back into the market, our gain per DBS share will be $20 - $15 = $5.

… a warrant is designed to have a short life and can expire quite quickly. New warrants can be issued with an expiry date of as short as 3 months.

However, a warrant is designed to have a short life and can expire quite quickly. New warrants can be issued with an expiry date of as short as 3 months. After a warrant is issued, we can buy or sell this warrant just like stocks until 5 trading days before its stated expiry date. If the DBS warrant we bought cannot be exercised because the underlying DBS share price did not move in our favour, the warrant expires worthless.

Another characteristic of warrants that investors must know is the exercise style. All call and put warrants can follow the European or American style. American-style warrants can be exercised at any time prior to its expiry date, while European-style warrants can only be exercised on its expiry date and not before. Fortunately, most warrants available on SGX belong to the European-style, simplifying one aspect for potential investors.

Comparing Warrants to Stocks:

… warrants allow us to invest with less money upfront and yet make bigger gains or losses …

There are at least 3 differences between warrants and stocks in Singapore that investors must be aware of. The first and most important difference is the leverage effect when investing in warrants. This means that warrants allow us to invest with less money upfront and yet make bigger gains or losses, as compared to investing the same amount of money in the underlying stock. The leverage effect is possible because warrants are much cheaper to buy than the underlying.

Using the DBS example again, each share of DBS may cost $12 to buy, but any warrants on DBS will cost much less, let’s say $0.50 per warrant. As the price of DBS shares change, the DBS warrant price also changes, but often by a much larger percentage. For this reason, we can get a larger gain or loss by investing in a DBS warrant compared to investing in DBS shares directly.

The other major difference between warrants and stocks is the limited life of a warrant. Stocks can be held for as long as you wish unless the company goes bankrupt. A warrant, however, always has a stated expiry date and is only appropriate as short-term investments.

Finally, the last difference is minor but nevertheless important to know. SGX charges a 0.04% clearing fee for stocks but a slightly higher clearing fee (0.05%) for warrants.

For more on warrants, do refer to the second and third articles that further explains why should we invest in warrants, factors that determine warrant prices, terms we will see when investing in warrants, investment strategies for warrants and all other important aspects that we must know before investing in warrants.