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What is a Warrant?

One of the key benefits of warrants is that they give investors the potential to maximise financial returns while strictly limiting potential losses. Importantly, warrants allow investors with either a bullish or bearish view to trade profitably through the issue of both call and put warrants.

 

One of the benefits of warrants is leverage. Put simply, warrants allow you to get exposure to a large amount of underlying shares for a relatively small capital outlay. Standard Bank, one of the leading issuers of warrants, offers a wide range of warrants over shares in some of South Africa’s leading companies and indices. Visit http://www.warrants.co.za for a full list of warrants that are available.

 

What is a warrant?

A warrant is a financial instrument that will pay out an amount of cash (or underlying) at a specified date in the future if the underlying on which it is based (most often a share or an index) is above (in the case of calls) or below (in the case of puts) a predetermined price (that is known as the strike or exercise price).

 

The two basic types of warrants are ‘call warrants’ and ‘put warrants’. Call warrants allow investors to profit from rising share prices. Put warrants allow investors to profit from falling share prices.

Warrants trade like any share listed on the JSE. Warrants are short-term trading instruments that will respond to moves in the underlying share. At all times the warrant will move in line with the underlying security and can be traded continuously and do not need to be held until expiry. With all else remaining equal, a call warrant’s price will increase as the underlying share or index increases and a put warrant’s price will increase if the underlying share or index decreases. This is how a warrant trader tries to make a profit, i.e. by selling the warrant at a higher price than what he paid for it.

 

If the share price remains the same, the warrant value will decay over time, all else being equal. The rate of decay will depend on several factors, but tends to increase as the warrant approaches the expiry date.

To allow investors to gauge the impact of changes of the underlying on the warrant Standard Bank publishes the prices at which it makes its markets on a pricing matrix which is accessible from the website http://www.warrants.co.za. Market makers use an automated market making system to keep the market running efficiently by continuously quoting both bid (buy) and offer (sell) prices in their warrants as per the matrix and this adds liquidity to the market ensuring that warrant traders are able to efficiently enter and exit positions.

 

Risks

The most obvious risk with trading warrants would be losses due to adverse movements in the underlying shares price resulting in a decrease of the warrant’s price.

While one of the key benefits of a warrant is the potential to maximise financial returns while limiting potential losses. There is a chance you could lose all the money invested in a warrant. Should a warrant expire out-the-money (see definition below), the warrant will expire worthless and you will receive no payment at expiry, losing the entire amount originally paid for the warrant.

 

A warrant will be in-the-money if the underlying on which it is based (most often a share or an index) is above (in the case of calls) or below (in the case of puts) the warrant’s strike price, Otherwise it will be out-the-money.

This article is intended to give a high level overview of what a warrant is. Should you be interested in trading warrants, we suggest you read more of the material online at http://www.warrants.co.za and look in the ‘help and education’ section. Look for the ‘warrants brochure’ and try the online course titled ‘warrants tutorial’.

 

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