We will now look at Equity Put Warrants. From now on we will just call them put warrants. You make money on put warrants when the value of their underlying share falls. I know they might seem to be difficult to understand at first but they are worth persevering with because you can then trade the market two ways. When it is going up you can trade call warrants and when it is going down you can trade put warrants.
Put warrants are available on 29 different shares that are listed on the ASX (as at September 2001).
Some shares only have one put warrant available while others, like the big banks and resource companies have several. At the time of writing NAB has 18 different put warrants available. They are offered by several different issuers, and they cover several different exercise prices, expiry dates and conversion ratios.
In table 3.1 below I have listed the ten shares which I trade put warrants over.
Table 3.1 The Shares that I Trade Put Warrants Over
| AMP | AMP | ANZ Bank | ANZ |
| BHP Biliton | BHP | Commonwealth Bank | CBA |
| National Aust. Bank | NAB | News Corporation | NCP |
| Rio Tinto | RIO | Telstra | TLS |
| Westpac | WBC | WMC | WMC |
I trade the put warrants over these shares because the trading volume is usually very good.
We use exactly the same terms to describe put warrants as we do to describe call warrants. Put warrant terms work in reverse to call warrant terms. See Table 3.2, it's based on the example put warrant NABWPT.
Out-of-the-Money
A put warrant is said to be "out-of-the-money when the price of its underlying share is greater than its exercise price.
Our example warrant NABWPT has an exercise price of $35.00. Whenever the price of NAB is above $35, NABWPT is said to be out-of-the-money.
At-the-Money
A put warrant is said to be "at-the-money" when the price of its underlying share is equal to its exercise price.
Our example warrant NABWPT has an exercise price of $35. Whenever NAB shares are priced at $35, NABWPT is said to be at-the-money.
In-the-Money
A put warrant is said to be "in-the-money" when the price of its underlying share is less than its exercise price.
Our example warrant NABWPT has an exercise price of $35. Whenever the price of NAB is below $35, NABWPT is said to be in-the-money.
Table 3.2 Put Warrant Trading Terms
| Underlying Share Price | Put Warrant Trading Terms NABWPT |
|---|---|
| $40.00 | Deep Out-of-the-money |
| $36.00 | Out-of-the-money |
| $35.00 | At-the-Money |
| $34.00 | In-the-Money |
| $30.00 | Deep-in-the-Money |
This example is based on the put warrant NABWPT which has an exercise price of $35.00.
The premium of a put warrant is the price that you paid to buy it. The value of the premium follows the value of the underlying share closely. It is made up of two different values, time value and intrinsic value. These two values mean the same as they do for call warrants, only they are calculated in a different way.
WARRANT PREMIUM = TIME VALUE + INTRINSIC VALUE
The intrinsic value of a put warrant is the difference between its exercise price and the price of its underlying share, divided by the conversion ratio of the warrant. If the difference is a negative answer then there is no intrinsic value.
In Table 3.3 below I have given some examples of the Intrinsic Value of NABWPT when NAB shares are trading at certain prices
Table 3.3 Intrinsic Value of NABWPT
| NAB Share Price | Intrinsic Value of NABWPT |
|---|---|
| $35.00 | No Intrinsic Value |
| $32.50 | $0.50 |
| $30.00 | $1.00 |
| $27.50 | $1.50 |
This example is based on the call warrant NABWPT which has an exercise price of $35.00 and a conversion ratio of 5:1.
NABWPT has an exercise price of $35 and a conversion ratio of 5:1. When NAB shares are trading at $35, NABWAB is said to be at-the-money. Its premium only consists of time value. It doesn't have any intrinsic value because its exercise price is the same price as NAB shares.
If the price of NAB shares were to fall to $32.50, then the premium of each NABWPT warrant would contain $0.50 worth of intrinsic value.
Intrinsic Value =$0.50
The Time value of a warrant is the difference between the price of the warrant (premium) and its intrinsic value. It is calculated in exactly the same way that it is for a call warrant.
TIME VALUE = WARRANT PREMIUM - INTRINSIC VALUE
We will work out the time and intrinsic values of NABWPT using real prices.
On the 21/06/01 NABWPT was priced at $0.38. NAB shares were priced at $32.30. Firstly, we need to work out the intrinsic value before we can work out the time value.
Intrinsic Value = (Exercise Price of the Warrant - Underlying Share Price) / Conversion Ratio of the Warrant
TIME VALUE = WARRANT PREMIUM - INTRINSIC VALUE
Time decay works in exactly the same way for put warrants as it does for call warrants. The time value is eroded away a little bit each day. You should only hold a put warrant while the price of the underlying share is falling.
A put warrant will generally lose one third of its time value during the first half of its life span, and the other two thirds during its second half. We will look at this more closely below using NABWPT again.
On the 20/08/01 NABWPT was priced at $0.47. NAB shares were priced at $33.05.
Intrinsic Value = (Exercise Price of the Warrant - Underlying Share Price) / Conversion Ratio of the Warrant
TIME VALUE = WARRANT PREMIUM - INTRINSIC VALUE
Time Value =
In the space of two months the time value of NABWPT has been eroded away by more than 60 percent. As I have said before, never hold a put warrant unless the price of its underlying share is falling.
The delta of a put warrant represents the change in value of a warrant compared to its underlying share. It is exactly the same as the delta of a call warrant, except that it is presented as a negative number between 0.00 to -1.00, or a percentage between 0% to -100%.
A put warrant that has a delta of -1.0 (-100%), means that if the value of the underlying share falls or rises by one cent, the value of the warrant will also rise or fall by one cent. A warrant that has a delta of -0.5 (-50%), means that if the value of the underlying share falls or rises by one cent, the value of the warrant will rise or fall by half a cent.
The value of the delta rises and falls with the value of the warrant. If the price of the put warrant's underlying share is 30% greater than the put warrant's exercise price, the put warrant will have a delta of zero. When the put warrant is at-the-money it will have a delta of -0.50 (-50%). If the price of the put warrant's underlying share is less than 70% of the put warrant's exercise price, the put warrant will have a delta of -1.0 (-100%).
The other factor that effects the delta of a put warrant, is the conversion ratio. A put warrant that has a conversion ratio of 1:1 has a delta range of 0.0 to -1.0. A put warrant that has a conversion ratio of 2:1, has a delta range of 0.0 to -0.50.
Our example warrant NABWPT has a conversion ratio of 5:1. It has a delta range of 0.0 to -0.2. Therefore, if NABWPT was at-the-money it would have a delta of -0.1. If NABWPT was deep in-the-money it would have a delta of -0.2.
It is important to remember that when you are choosing between different put warrants to trade, warrants that are just out-of-the-money or at-the-money usually offer the best returns. Table 3.4 below shows how the delta changes as the price of the underlying share changes.
Table 3.4 Delta of a Put Warrant
| Underlying Share Price | Approximate Delta of a Call Warrant |
|---|---|
| 130% | 0.00 |
| 110% | -0.20 |
| 100% | -0.50 |
| 90% | -0.80 |
| 70% | -1.00 |
Price of the underlying share is expressed as a percentage of the put warrant's exercise price.
There are a few other factors that can effect the premium of a put warrant. I will briefly describe them below.
Volatility
The volatility of the underlying share can effect the put warrant premium in exactly the same way that it effects call warrant premiums. If the volatility of the underlying share increases, the put warrant's premium will also increase. It is not necessary to know how to calculate volatility, only to know that it exists.
Dividends
When the underlying share of a put warrant goes ex-dividend, the value of the put warrant will decrease. To work out how much the put warrant's premium will fall by you need to find out how much the dividend payment is and then find out the delta of the warrant. It is simply a matter of multiplying the dividend payment by the delta of the warrant. The answer should equal the amount that the warrant's value will drop by.
Interest Rates
Interest rates can also effect the value of a put warrant. When interest rates rise put warrants generally become cheaper. When interest rates fall put warrants generally become dearer. It is not necessary to know how to calculate this, only to know that it exists.
The trading volume of a put warrant varies accordingly to the present value of its underlying share and the value of its exercise price. It is exactly the same for put warrants as it is for call warrants.
The best time to trade a put warrant is when it is at-the-money. You buy them when they are at-the-money and the volume is starting to increase. You sell them when they are in-the-money and the volume is still strong.
This price and volume relationship is worth remembering because it helps us to choose the best warrants to trade.
Leverage tells us, how much the warrant premium will rise (or fall), compared to a 1% rise (or fall) in the price of the underlying share. The answer is expressed as a percentage. The leverage (or gearing) that a put warrant offers is calculated in exactly the same way that it is calculated for call warrants.
Using our example warrant NABWPT, we will work out the leverage that it offered on the 10th September 2001.
Leverage = (Underlying Share Price / Warrant Premium) x Warrant's Delta
In the example above, NABWPT offers a 5.46% rise (or fall) compared to a 1% fall (or rise) in the price of NAB shares.
Another way of putting it is, buying $1000 of NABWPT warrants gives the same exposure as buying $5460 of NAB shares.
Warrant issuers are obligated to make a market for their warrants. This means that they are supposed to maintain a bid/ask spread for their warrants at all times. (Although there is no law saying how large or small these spreads should be.) Warrant issuers post a price matrix on their website, which states what their bids and asks will be when the underlying share is trading at certain prices. They also usually contain the terms of the warrant as well. See Table 3.5 below for an example.
In Table 3.5 there are three columns labelled Basis, Bid and Ask. These columns state what the bids and asks will be when the underlying share is trading at the price stated in the 'basis' column.
In our example NAB shares closed at $29.30. The issuer's bid for NABWPT at this level would be $1.13 and their ask would be $1.14. If NAB shares were trading at $29.14, the issuer's bid would be $1.16 and their ask would be $1.17.
NABWPT
| Warrant Type | Put |
| Exercise Style | European |
| Exercise Price | $35.00 |
| Expiry Date | 25-OCT-01 |
| Conversion Ratio | 5:1 |
| Delta | -0.19 |
Table 3.5 Example Price Matrix for NABWPT
| Basis | Bid | Ask |
|---|---|---|
| $29.14 | $1.16 | $1.17 |
| $29.18 | $1.15 | $1.16 |
| $29.22 | $1.15 | $1.16 |
| $29.26 | $1.14 | $1.15 |
| $29.30 | $1.13 | $1.14 |
| $29.34 | $1.12 | $1.13 |
| $29.38 | $1.12 | $1.13 |
| $29.42 | $1.11 | $1.12 |
| $29.46 | $1.10 | $1.11 |
Information on warrant premiums and terms can generally be found on the website of their issuer. See the page Warrant Issuers for a list of warrant issuers and their websites.
I will now summarise the different factors that have an effect on the value of a put warrant.
| Underlying Share Price Increases | Put Warrant Premium Decreases |
| Underlying Share Price Decreases | Put Warrant Premium Increases |
| Time to Expiry Decreases | Put Warrant Premium Decreases |
| Volatility Increases | Put Warrant Premium Increases |
| Volatility Decreases | Put Warrant Premium Decreases |
| Underlying Share Goes Ex-Dividend | Put Warrant Premium Decreases |
| Interest Rates Increase | Put Warrant Premium Decreases |
| Interest Rates Decrease | Put Warrant Premium Increases |