In this posting, I’m going to discuss about the effect of tick value on warrants. With effect from 24th December 2007, SGX had revised the minimum bid sizes for its various financial instruments products. I am interested in the revised minimum bid size for securities. Under the new revised schedule, any securities trading below $1.00 have a minimum bid size of $0.005. Securities trading between $1.00 and $9.99 have a minimum bid size of $0.01. Securities trading $10.00 and above have a minimum bid size of $0.02. With this new revised minimum bid sizes in mind, I’m going to use Singapore Exchange (SGX) as an example for my discussion.
When SGX is trading at close to $10.00 in January this year, we can see that some of the warrants derived from it are lagging behind, while some others follow closely but with a bigger bid/ask spread. You can easily verify this by randomly looking at how closely the warrant price follows the stock price under the Data & Chart > Historical Price at SG Warrants. For easy reference, I have randomly capture three images for some SGX call warrants.
The examples I used here are not really perfect and one will be right to argue that there are some other factors (e.g. such as trading volume on that particular day) that causes the charts to be difference. Nevertheless, they are good enough to illustrate the point I’m going to discuss.
From the screen captures I have done, you will notice that for some warrants, the price of the warrant will follow very closely with that of the underlying stock while on the other hand, some of them do not follow as closely. Of course, for put warrants, the prices move in opposite direction of the underlying stock.
Assuming SGX is trading close to $10.00 at this point of time. The next tick will either bring the stock price up to $10.02 or $9.98. Hence, in this example here, a $0.02 change will mean a 0.2% increase or decrease in the underlying price. If the warrant has an effective gearing of 10 times, this $0.02 change in the underlying will be enlarged to a 2% (10 X 0.2%) change in warrant price.
Looking at another perspective, suppose we have a SGX warrant with a delta of 40% and a conversion ratio of 1:1, then for every $1.00 change in the underlying price, the warrant should, in theory, rise or fall by $0.40. So, for every $0.02 change in stock price, the warrant should move by $0.008 ($0.02 X 0.4). If the face value of the warrant is above $1.00, its tick value will be $0.01. For each tick ($0.02) of movement in the underlying price, the warrant will move by $0.008, which is not enough to make a tick in the warrant price. It appears that the warrant is lagging behind. However, if the warrant’s face value is below $1.00, its tick value will be $0.005. In this case, for every tick ($0.02) of movement in the underlying price, the warrant price will move by 1.6 ticks. Hence, if one goes for a warrant with a high delta and smaller face value, one may expect to see some movements in the warrant price.
In the face of technical issues, different issuers opt for different treatments. Some leave their warrants to swing up and down with the underlying securities, which indirectly increases the trading risk. Others take action to even out the fluctuations and make their warrants move up and down in an orderly manner (so that the warrant price will follow the underlying price to take on the ask side or the bid side). Still others choose to widen the bid/ask spreads of their warrants.
Investors should understand that there exist various technical issues in the market. We should not hastily jump to the conclusion based on the varied performance of different warrants that this or that issuer is not doing a good job. The truth may boiled down to the different treatments adopted by the issuers.
