Wednesday, 6 February 2008

Analysis of Warrant Data (Part 5)

Hi my readers, I am sorry for not posting for awhile. I have been busy doing spring cleaning :) Now my room has once again regained its cleanliness. I am going to continue my posting on analysis of warrant.

There was an article on My Paper on the 1st of Feb 2008, which was last week, regarding option trading. I am not too sure if anyone had read about the article? In the article, there was a short mentioned about the yield curve, a methodology to peek where our economy is heading towards to in year 2008 and perhaps the next one to two years to come. In fact, last year November, I had a similar post to explain the shapes of the yield curves and its implication on the economy. That was one of the reasons I started to monitor the STI put warrants since beginning this year, but I did not trade any of them, at least not using real money. :(

Anyway, I am a novice and risk adverse investor and I do not want to jump straight into the market before I understand how warrants work for me. It is like learning how to drive. We all started on circuit then we moved on to the roads and once we are familiar with it, we can drive safely on roads. Thought that does not guarantee you will not meet up with any accidents (touch wood) but at least you are more cautious and know what to look out for. Hence I do encourage novice investors and traders who wish to trade warrants or stocks to start doing virtual trade and make it as real as possible. Once you are able to reap consistent profit from your virtual trading, then perhaps it is time for you to test out your concepts and skills in the real market. Just remember to minimize your losses and let your profits run.

I would like to continue to share what I have learnt so far in warrant trading. This post is about premium. Premium is a measure of how much the underlying price has to move for the warrant to break even if it is held to maturity.

The premium for a call warrant =

([Strike Price + Warrant Price * Conversion Ratio] – Underlying Price) / Underlying Price * 100%

Whereas, Warrant Price * Conversion Ratio is the cost of buying a warrant, and Strike Price + Cost component is the breakeven point of the warrant. In this formula, we first calculate the difference between the breakeven point and the underlying price and then divide it by the underlying price to find out the premium as a percentage.

Likewise, the premium for a put warrant =

(Underlying Price - [Strike Price - Warrant Price * Conversion Ratio]) / Underlying Price * 100%

For example, the recently listed UOB call warrant UOB BNP ECW100319 is trading at SGD$0.315 at point of writing, with strike of SGD$15.38 and a conversion ratio of 14.993:1. The underlying price is SGD$17.36 at point of writing, then the premium is

Premium = (S$15.38 + S$0.315 * 14.993 - S$17.36) / S$17.36 * 100% = 15.80%
Breakeven = S$15.38 + S$0.315 * 14.993 - S$17.36 = S$20.10

In other words, if the investor intends to hold the warrant until maturity, its takes 15.8% increase in the underlying price from its current level of S$17.36 to S$20.10 to breakeven. In this example, what we have is an in-the-money (ITM) warrant, and the underlying needs a modest increase in the underlying price to breakeven. In the case of an out-of-the-money (OTM) warrant, the underlying must make a bigger climb to reach the breakeven point.

To sum up, the premium only measures the percentage increase in the underlying price that will allow the warrant investor to breakeven upon maturity. It does not tell us whether the price of a warrant is too high or too low. Hence, unless you are prepared to hold the warrant until maturity, premium is not a relevant indicator for you.

Today is Lunar New Year eve, I hereby wish everyone 恭喜发财,万事如意.

1 comment:

Collin Yeo said...

Hi Neaven,

does that means that a negative premium actually represent a gain if the warrant is exercised?