Warrants are a type of derivative, that are issued by banks and other institutions, which are traded on the Australian Stock Exchange (ASX). They are called derivatives because their value is derived from something else (usually an underlying share). A warrant is a type of option, that gives the holder the right to buy, sell, or to do nothing with an underlying share, at an agreed price, at or until a set date in the future. Warrants are traded on the ASX in exactly the same way that shares are. People are attracted to them because they offer fantastic gains (and also losses) for a very small outlay.
An equity call warrant gives the holder the right to buy (or call on delivery of) the underlying share from the issuer (or do nothing), at a set price, on or before a particular date. From now on we will just call them call warrants.
An equity put warrant gives the holder the right to sell (to "put") the underlying share to the issuer (or do nothing), at a set price, on or before a particular date. From now on we will just call them put warrants.
An instalment warrant gives the holder the right to buy the underlying share with two or more instalment payments.
An index warrant is issued over an underlying index (eg. S&P/ASX 200). They are similar to equity warrants. The holder benefits from the rises and the falls in the value of the underlying index.
Endowment warrants are long-term investment style warrants that have a life span of up to ten years. They are structured so that between 30 - 60 percent of the premium is paid up front and the dividends are used to reduce the outstanding amount.
Capital plus warrants are issued over a basket of shares that are specified by the issuer. The holder benefits if the underlying shares rise in value. Capital plus Warrants are also capital protected. This means that if the underlying shares fall in value the holder will receive back their original amount that they paid for them.
Currency Warrants are issued over an underlying currency. They are similar to equity warrants. The holder benefits from the rises and the falls in the value of the underlying currency.
Every warrant that is listed on the ASX has its own special six-letter code. Let's use the warrant NABWAB as an example. The first three letters are the share code of the warrant's underlying share. In this case it is the National Australia Bank (NAB).
The fourth letter is either W, I, E or X. It tells us what type of warrant it is. (Please note that equity, index and currency warrants all share the letter W, as they are all considered to be trading warrants.) In our example, NABWAB is an equity warrant because NAB is the underlying share. In Table 1.1 below, I have listed out the main types of warrants and their fourth letter codes.
The fifth letter of the code tells us who issued the warrant. Our example warrant NABWAB, was issued by the ANZ Bank. Table 1.2 below is a list of the warrant issuers and their codes.
The last letter of the code is the market code for that particular series of warrants. Generally call warrants are sequentially allocated the letters A - O and put warrants are sequentially allocated the letters P - Z. See Table 1.3 below for a summary.
Table 1.1 Warrant Types
| Warrant Type | Code | Warrant Type | Code |
|---|---|---|---|
| Equity | W | Endowment | E |
| Instalment | I | Currency | W |
| Index | W | Capital Plus | X |
Table 1.2 Warrant Issuers
|
Table 1.3 Example of a Warrant Code
| NAB | W | A | B |
|---|---|---|---|
| Underlying Share Code | Warrant Type | Warrant Issuer | Market Code for that Series |
We will stay with our example NABWAB. It is a call warrant that was issued by the ANZ Bank. The underlying share is NAB. We would buy this warrant if we thought the price of NAB shares was going to rise. I will also introduce the put warrant NABWPT for a comparison. We would buy this warrant if we thought the price of NAB shares was going to fall. Every warrant comes with it's own set of conditions that are set, by the issuer, when the warrant is issued. In Table 1.4 below, I have listed out the conditions that apply to our two example warrants.
Table 1.4 Warrant Terms
| Warrant Name | Exercise Price | Expiry Date | Conversion Ratio | Exercise Style |
|---|---|---|---|---|
| NABWAB | $30.00 | 25/10/01 | 4:1 | American |
| NABWPT | $35.00 | 25/10/01 | 5:1 | European |
All warrants come with an expiry date, which means they have a limited life span. Equity warrants are generally issued with a life span of between 3 - 12 months. Endowment and instalment warrants are issued with a life span of up to ten years.
The term exercise, in the case of a call warrant, means that you want to convert the warrant into the underlying shares. In the case of a put warrant it means that you want to sell (or "put") the underlying shares to the warrant issuer.
Call Warrant: You pay the warrant issuer the exercise price if you want to exercise a call warrant.
Put Warrant: The warrant issuer pays you the exercise price if you want to exercise a put warrant.
The exercise price, in the case of a call warrant, is the price that you have to pay to convert the warrant into the underlying share.
Our example warrant NABWAB has an exercise price of $30.00. This means that it will cost you $30 to convert it into a NAB share. If the price of NAB shares rose to $35, you could exercise the warrant for $30 and then sell the shares on the market for $35. If the price of NAB shares fell to $25, when NABWAB reached its expiry date, it would expire worthless and you would lose the premium that you paid for it.
The exercise price, in the case of a put warrant, is the price that the warrant issuer will pay you for the underlying share. Let's say you owned some NAB shares and you thought the price of them were going to fall. You could buy a put warrant like NABWPT, to protect the value of your shares.
NABWPT has an exercise price of $35.00. If the price of NAB shares were to fall to $30, you could exercise the warrant. That means the issuer of the warrant would buy your NAB shares from you for $35. If the price of NAB shares had risen to $40, when NABWPT reached it's expiry date, it would expire worthless and you would lose the premium that you paid for it.
The conversion ratio is the number of warrants that must be exercised to require the transfer of one underlying share. Equity warrants can have conversion ratios of 1:1, 2:1, 3:1, 4:1, 5:1 and 10:1. Generally, the higher the conversion ratio, the lower the cost of the warrant. Endowment and Instalment warrants generally have a conversion ratio of 1:1.
In our examples, NABWAB has a conversion ratio of 4:1. This means that you would have to exercise four warrants to receive one share from the warrant issuer.
NABWPT has a conversion ratio of 5:1. This means that you would have to exercise five warrants for every share that you wanted to sell to the issuer.
Warrants have two different types of exercise styles, American and European. American style means that you can exercise the warrant at any time on or before the expiry date. European style means that you can only exercise the warrant on the expiry date.
Equity warrants are traded in lots of 1,000. Instalment warrants are generally traded in lots of 250.
The premium is the price that you have to pay to buy the warrant.
Warrants are issued by large banks and financial institutions. After they are issued they can be traded on the ASX in exactly the same way that shares are. Warrant issuers undertake to the ASX to maintain markets for the life of their warrants.
Trading information is available from a number of sources. Major newspapers and The Australian Financial Review publish the prices of warrants daily. Websites such as the ASX (www.asx.com.au) and Parity (www.parity.com.au), which is provided by BNP Paribas, also have warrant prices and other information available daily.
There are a couple more terms that we need to learn before we can trade warrants. See Table 1.5 below.
Table 1.5 Warrant Trading Terms
| Warrant Code | Bid | Ask | Last Sale | Volume (00's) |
|---|---|---|---|---|
| NABWAB | $0.215 | $0.225 | $0.22 | 27507 |
| NABWPT | $1.15 | $1.16 | $1.14 | 270 |
Bid: A bid is the price that a buyer is willing to pay you for your warrants.
Ask: Ask is the price that a seller hopes to sell their warrants for. It can also be called the asking or offering price.
Spread: The spread is the difference between the bid and the ask price.
Volume: Volume is the total number of warrants that have been traded during that particular trading session.
An offering circular is released for every series of warrants that are issued. It contains the terms of issue for that particular warrant series. They are available either from the issuer's or the ASX website.