Actual Operation of Warrant Trading (Part 3)

This is the third part of the Actual Operation of Warrant Trading. In this post, I’ll discuss about the face value of warrant. Some investors prefer warrants with a smaller face value, because they cost less to buy and the tick value is lower, and they are more sensitive to the movement of the underlying price. However, other investors prefer warrants with a bigger face value, on the grounds that, with their higher tick value, one tick will be enough to pay the brokerage commission.

So, is it a better strategy to buy warrants with smaller face value or those with a bigger face value? Lets us find it out by comparing transaction costs and how closely the warrant price will follow the movement of the underlying price.

Let us start with transaction costs. Assume that the bid/ask spread of the warrants is one tick across the board. For a warrant with a face value of no more than S$1.00, say S$0.50, the tick value is S$0.005. This is also the minimum transaction cost for buying and selling the warrant, with the underlying price remaining unchanged. For another warrant with a face value within the range between S$1.00 and S$9.99, say S$5.00, the tick value of the warrant is S$0.01. It seems that the warrant with a bigger face value is more costly. In fact, this is not true. In percentage terms, the transaction cost is actually higher for warrants with a smaller face value. In the case here, the warrant with a smaller face value, S$0.005 / S$0.50 * 100 = 1%, compared with the warrant with a bigger face value, S$0.01 / S$5.00 * 100 = 0.2%. Hence, the trading risk is relatively lower for the latter.

Besides, a warrant with a smaller face value is more likely to follow closely the movement of its underlying. Say, we have two warrants, both with a delta of 0.05 and a conversion ratio of 10:1. For the one with a smaller face value, its tick value is S$0.005. When its underlying goes up by S$0.10, the warrant will in theory, climb by 1 tick (S$0.1 * 0.05 = S$0.005). As for the warrant with a bigger face value, its tick value is S$0.01. When the underlying goes up by S$0.10, the warrant will appear to be not moving at all, as the increase in its price is less than a tick (S$0.005 = ½ tick).

Face value may be more relevant to investors looking for fast money. For ordinary investors, it does not mean much whether it is S$0.005 or S$0.01 a tick. Of course, we always want to buy something at a lower cost if possible. Nevertheless, you are advised not to be too concerned with the tick value, but spend more time studying the terms such as effective gearing, to find out the most suitable warrant for your portfolio.