Saturday, 19 January 2008

Analysis of Warrant Data (Part 2)

I believed by now, most of you have noticed the Singapore market had tanked more than 10% (based on the STI index) since beginning of this year. If you have read my blog earlier on regarding the “Yield Curve for Bonds” and if you have understood what the inverted yield curves really mean, and if you have read up more on warrants, I believe you may have earn quite a lot from buying the STI put warrants. One of the put warrants I was monitoring has risen more than 50% in price since beginning of this year and another is most likely going to expired in-the-money (ITM) in another 10days time. Well I am not encouraging anyone to go jump in the market and buy the STI put warrants now. The STI index has shown some signs of reversal for the last two days and some put warrants have drop in price. Give yourself some times and learn more about warrants before you embark your journey to warrant trading.

This post is a continuation of my previous post on Analysis of warrant data. Some of you might have known this already but to make it more complete, I will try not to miss out anything about warrants. What do we mean when we say a warrant or option is in-the-money? A warrant is described as in-the-money (ITM), at-the-money (ATM) or out-of-the-money (OTM), depending on the relationship between its strike price and its underlying price. A call warrant is OTM when its strike price is higher than its underlying price. In contrast, when its strike price is lower than its underlying price, the call warrant is ITM. The situation is just opposite for put warrants. When its strike price is higher than its underlying price, a put warrant is ITM; and when its strike price is lower than its underlying price, it is OTM. No matter it is call or put, if the strike is equal to the underlying price, the warrant is said to be ATM. The above is summarized below:
  • In-the-money : Call warrant – Strike price less than Underlying price
  • At-the-money: Call warrant – Strike price equals Underlying price
  • Out-of-the-money: Call Warrant – Strike price greater than Underlying price
  • In-the-money : Put warrant – Strike price greater than Underlying price
  • At-the-money: Put warrant – Strike price equals Underlying price
  • Out-of-the-money: Put Warrant – Strike price less than Underlying price

If we take into account the extent of the difference between the strike price and the underlying price, warrants can be further classified into ITM, deep ITM, OTM and far OTM. Generally, where there is a 15% or above difference between the strike price and the underlying price, a warrant will be considered far OTM or deep ITM. However, this 15% mark is merely a rough idea, not an absolute threshold. One must also look to the volatility of the underlying. Some warrants may be considered deep ITM or far OTM even if the difference between strike price and the underlying price is only 10% or more.

Besides classifying warrants in term of moneyness i.e. ITM, OTM or ATM, warrants can be classified accordingly to the length of their remaining days to maturity. Normally, we will describe a warrant with less than 3 months to maturity as a short-term warrant; one with 3 to 6 months left to maturity a medium-term warrant; and one with more than six months running to maturity as a long term warrant.

If we also take into account whether a warrant is ITM, ATM or OTM, a general investor may consider a medium-term warrant with around 3 months running to maturity and a strike price around 5% above or below the underlying price. More aggressive investors may go for OTM warrants with a shorter maturity. For conservative investors, they may choose ITM warrants with longer maturity.

Whether it is long-term or short term, ITM or OTM, a warrant is after all a leveraged investment instrument. Be cautious in funds allocation and stop-loss arrangements. Do not get carried away by the potential return without considering your risk tolerance.

Personally, if I am willing to invest say, SGD$400 to buy warrants, then SGD$400 is the amount I am willing to lose if I hold onto maturity and the warrant expire OTM. Hence, be very careful with your money management. If you do not intent to hold the warrant till maturity, then as a general guideline, sell off your warrants 30 days before they get expire. Another personal advice from me, although we can trade warrants like stock meaning we are able to short sell warrants, please DO NOT ever do it, unless you really know what you are doing? I will keep up with my posting on warrants soon. Have a nice day. Oh, please kindly vote in my blog too. :)


Tony Chai said...

Hi :

Nice to know someone who's skilled in trading structured warrants.

I hope to trade some structured put warrants for the properties group and wonder which are the counters, in your opinion, should I should pay attention to?

I wanted to open a trading account to trade structured warrants. Which brokering firm in Singapore would you recommend?

Thanks !!

Tony Chai
Options Trading Blog

Neaven said...

Hi Tony, thanks for your compliment. I do not really consider myself skilled in warrant trading now, but I’ll put in more efforts to master it. As a matter of fact, I’m a beginner myself. I created spreadsheet to monitor the warrants which I think are good and make it a point to really understand what I am doing before I jump into the market. I’m a risk adverse person. I’m really not in any position to recommend any good warrant for properties market simply because I do not monitor the properties market and the fact that I’m still a green horn, I seriously do not wish to give you wrong information.

As a matter of fact, from your blog, I would like to learn more about option trading from you. Can I link your blog to my?

Yup, before I forgot, I just used my P.O.E.M account for trading warrant. I’m not too sure if other accounts are better or not? My colleague did mention to me that her UOB Kay Hian does not allow her to trade warrant though.

Tony Chai said...

Hi Neaven :

No problem about the linking. I would also put your blog link in my blog.

Yes, we could certainly exchange experiences. If you're in Singapore, may be we could meet up, easier to talk face to face.

You mentioned you've an article “Yield Curve for Bonds”, may I have a URL link to it? Thanks.


Tony Chai
My Options Trading Blog

Neaven said...

Hi Tony, sorry for my late reply. I have been busy doing spring cleaning hee hee. Yup, I stay in Singapore as well. We sure can meet up :) I had a previous post on the yield curve for bonds. There was an article on My paper on 1st Feb 2008 that mentioned something on the three-month T-Bill and 10-year note as well. If you have the paper you may be interested to read it. Its on page A15.

Ben Lee said...

Hi Neaven,
Nice article from you on warrants.
I would like to check with you, when you said that we can short-sell warrants, is this really allow across all the brokers?

I did also read somewhere that SGX kind of ban short-selling of warrants, is that true?

Neaven said...

Hi Ben, hmmm that is really a good question. My understanding is, a warrant trades like a stock, and a stock can be short and therefore I see no reason why we cannot short a warrant? Though I do not seriously recommend you to do so. Shorting warrants, especially the call warrants, are unlimited risk. I'm not too sure if there is such regulation from SGX that you cannot short warrant. Let me find it out for you.

Neaven said...

Hi Ben, I have checked with a friend working with phillipCapital. You can short warrant but just be very careful especially for those warrants going to expire. This is because, as the warrants approach expiry date, there may be no buyer and if you failed to buy back the warrants by t+3 after you short, the broker will buy back the warrants for you on t+4. The price bought back could be 100% higher compared to stocks. Hope this helps you, but anyway, don't short :)