Covered warrant
Encyclopedia
In finance
a covered warrant (sometimes called naked warrant) is a type of warrant
that has been issued without an accompanying bond
or equity
. Like a normal warrant it allows the holder to buy or sell a specific amount of equities, currency or other financial instruments from the issuer at a specified price at a predetermined date.
Unlike normal warrants they are usually issued by financial institution
s instead of share issuing companies and are listed as full tradeable securities
on a number of stock exchanges. They can also have a wide variety of underlying instruments, not just equities and may allow the holder to both buy or sell the underlying asset. These attributes make it possible to use covered warrants as a tool to speculate on financial markets.
' warrant) or to sell ('put
' warrant) an underlying asset at a specified price (the 'strike' price or 'exercise' price) by a predetermined date. The price paid for this right is the 'premium' and with covered warrants you cannot lose more than this initial premium
paid. They are limited liability instruments so there are no further payments or margin call
s required to maintain a covered warrant position. Covered warrants offer a flexible alternative to private investors who seek to gain the leverage
benefits of derivatives, but who wish to limit their risk.
When the issuer sells a warrant to an investor, they typically 'cover' (hedge) their exposure by buying the underlying instrument in the market. Covered warrants have an average life of six to 12 months, although some have maturities
of several years.
In contrast to 'traditional' equity warrants, with covered warrants no new issuance of common stock
occurs if the warrant is exercised. The underlying shares of common stock are usually either owned by the issuer of the covered warrants or the issuer has a mechanism, such as owning equity warrants for the underlying shares, through which they can obtain the shares. Covered warrants have proved highly popular due to their:
, Singapore Exchange
and Hong Kong Stock Exchange
and have proved popular with individual investors and traders particularly in Hong Kong
, China
and Europe
(especially Italy
) . They are seen as a flexible tool offering leveraged exposure to a wide range of underlying
s such as equities
, baskets
, indices, currencies and commodities, while offering the benefits of transparency
and liquidity.
For example, popular indices include the FTSE100
in the UK or DAX in Germany, and popular commodities include oil
, gold
and wheat.
as the warrant will be profitable only when the market price exceeds the strike price for a 'call warrant' or is below the strike for a 'put warrant'. The inherent leveraging effect of the warrant significantly increases the risks and traders that are using warrant to speculate can make or lose significant sums very quickly. With covered warrants the maximum loss is limited to the price paid for the warrant (ask or offer price) plus any commission or other transaction charges. Thus, although warrants are classed as high risk they are not as risky as other investment products such as contracts for differences
or spread betting
in which an investor would have to pay for future losses.
Another aspect of risk is that an investor could lose their entire investment if the corporation issuing the warrant becomes insolvent.
Finance
"Finance" is often defined simply as the management of money or “funds” management Modern finance, however, is a family of business activity that includes the origination, marketing, and management of cash and money surrogates through a variety of capital accounts, instruments, and markets created...
a covered warrant (sometimes called naked warrant) is a type of warrant
Warrant (finance)
In finance, a warrant is a security that entitles the holder to buy the underlying stock of the issuing company at a fixed exercise price until the expiry date....
that has been issued without an accompanying bond
Bond (finance)
In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest to use and/or to repay the principal at a later date, termed maturity...
or equity
Equity (finance)
In accounting and finance, equity is the residual claim or interest of the most junior class of investors in assets, after all liabilities are paid. If liability exceeds assets, negative equity exists...
. Like a normal warrant it allows the holder to buy or sell a specific amount of equities, currency or other financial instruments from the issuer at a specified price at a predetermined date.
Unlike normal warrants they are usually issued by financial institution
Financial institution
In financial economics, a financial institution is an institution that provides financial services for its clients or members. Probably the most important financial service provided by financial institutions is acting as financial intermediaries...
s instead of share issuing companies and are listed as full tradeable securities
Security (finance)
A security is generally a fungible, negotiable financial instrument representing financial value. Securities are broadly categorized into:* debt securities ,* equity securities, e.g., common stocks; and,...
on a number of stock exchanges. They can also have a wide variety of underlying instruments, not just equities and may allow the holder to both buy or sell the underlying asset. These attributes make it possible to use covered warrants as a tool to speculate on financial markets.
Structure and features
A covered warrant gives the holder the right, but not the obligation, to buy ('callCall option
A call option, often simply labeled a "call", is a financial contract between two parties, the buyer and the seller of this type of option. The buyer of the call option has the right, but not the obligation to buy an agreed quantity of a particular commodity or financial instrument from the seller...
' warrant) or to sell ('put
Put option
A put or put option is a contract between two parties to exchange an asset, the underlying, at a specified price, the strike, by a predetermined date, the expiry or maturity...
' warrant) an underlying asset at a specified price (the 'strike' price or 'exercise' price) by a predetermined date. The price paid for this right is the 'premium' and with covered warrants you cannot lose more than this initial premium
Premium
Premium may refer to:* Premium , a promotional item that can be received for a small fee when redeeming proofs of purchase that come with or on retail products....
paid. They are limited liability instruments so there are no further payments or margin call
Margin Call
Margin Call is a 2011 American independent drama film, written and directed by J.C. Chandor. The film has an ensemble cast that includes Kevin Spacey, Demi Moore, Paul Bettany, Jeremy Irons, Zachary Quinto, Stanley Tucci, Simon Baker, and Penn Badgley...
s required to maintain a covered warrant position. Covered warrants offer a flexible alternative to private investors who seek to gain the leverage
Leverage (finance)
In finance, leverage is a general term for any technique to multiply gains and losses. Common ways to attain leverage are borrowing money, buying fixed assets and using derivatives. Important examples are:* A public corporation may leverage its equity by borrowing money...
benefits of derivatives, but who wish to limit their risk.
When the issuer sells a warrant to an investor, they typically 'cover' (hedge) their exposure by buying the underlying instrument in the market. Covered warrants have an average life of six to 12 months, although some have maturities
Maturity (finance)
In finance, maturity or maturity date refers to the final payment date of a loan or other financial instrument, at which point the principal is due to be paid....
of several years.
In contrast to 'traditional' equity warrants, with covered warrants no new issuance of common stock
Common stock
Common stock is a form of corporate equity ownership, a type of security. It is called "common" to distinguish it from preferred stock. In the event of bankruptcy, common stock investors receive their funds after preferred stock holders, bondholders, creditors, etc...
occurs if the warrant is exercised. The underlying shares of common stock are usually either owned by the issuer of the covered warrants or the issuer has a mechanism, such as owning equity warrants for the underlying shares, through which they can obtain the shares. Covered warrants have proved highly popular due to their:
- low cost
- flexibility
- limited liability
- multi-strategy options
Comparison with options
Covered warrants are very similar to options, much more so than 'traditional' warrants. This is because covered warrants, just like options, can be created to allow holders to benefit from either rising prices or falling prices, by having both put and call warrants. They can also be created on a wide variety of underlying instruments not just equities and there are fairly standardised and are mostly traded on exchanges. The main difference is that warrants tend to have longer maturity dates typically measured in years instead of months as with options, and are easier to access for individuals as they can be bought and sold in the same way as shares in the stock exchange.Trading warrants
Warrants are listed on a number of major exchanges, including the London Stock ExchangeLondon Stock Exchange
The London Stock Exchange is a stock exchange located in the City of London within the United Kingdom. , the Exchange had a market capitalisation of US$3.7495 trillion, making it the fourth-largest stock exchange in the world by this measurement...
, Singapore Exchange
Singapore Exchange
Singapore Exchange Limited is an investment holding company located in Singapore and providing different services related to securities and derivatives trading and others. SGX is a member of the World Federation of Exchanges and the Asian and Oceanian Stock Exchanges FederationSingapore Exchange...
and Hong Kong Stock Exchange
Hong Kong Stock Exchange
The Hong Kong Stock Exchange is a stock exchange located in Hong Kong. It is Asia's third largest stock exchange in terms of market capitalization behind the Tokyo Stock Exchange and the Shanghai Stock Exchange and fifth largest in the world...
and have proved popular with individual investors and traders particularly in Hong Kong
Hong Kong
Hong Kong is one of two Special Administrative Regions of the People's Republic of China , the other being Macau. A city-state situated on China's south coast and enclosed by the Pearl River Delta and South China Sea, it is renowned for its expansive skyline and deep natural harbour...
, China
China
Chinese civilization may refer to:* China for more general discussion of the country.* Chinese culture* Greater China, the transnational community of ethnic Chinese.* History of China* Sinosphere, the area historically affected by Chinese culture...
and Europe
Europe
Europe is, by convention, one of the world's seven continents. Comprising the westernmost peninsula of Eurasia, Europe is generally 'divided' from Asia to its east by the watershed divides of the Ural and Caucasus Mountains, the Ural River, the Caspian and Black Seas, and the waterways connecting...
(especially Italy
Italy
Italy , officially the Italian Republic languages]] under the European Charter for Regional or Minority Languages. In each of these, Italy's official name is as follows:;;;;;;;;), is a unitary parliamentary republic in South-Central Europe. To the north it borders France, Switzerland, Austria and...
) . They are seen as a flexible tool offering leveraged exposure to a wide range of underlying
Underlying
In finance, the underlying of a derivative is an asset, basket of assets, index, or even another derivative, such that the cash flows of the derivative depend on the value of this underlying...
s such as equities
Equity (finance)
In accounting and finance, equity is the residual claim or interest of the most junior class of investors in assets, after all liabilities are paid. If liability exceeds assets, negative equity exists...
, baskets
Basket (finance)
A basket is an economic term for a group of several securities created for the purpose of simultaneous buying or selling. Baskets are frequently used for program trading.Certain specific products can be seen as specialized "baskets"....
, indices, currencies and commodities, while offering the benefits of transparency
Transparency (market)
In economics, a market is transparent if much is known by many about:* What products, services or capital assets are available.* What price.* Where....
and liquidity.
For example, popular indices include the FTSE100
FTSE 100 Index
The FTSE 100 Index, also called FTSE 100, FTSE, or, informally, the footsie , is a share index of the 100 most highly capitalised UK companies listed on the London Stock Exchange....
in the UK or DAX in Germany, and popular commodities include oil
Oil
An oil is any substance that is liquid at ambient temperatures and does not mix with water but may mix with other oils and organic solvents. This general definition includes vegetable oils, volatile essential oils, petrochemical oils, and synthetic oils....
, gold
Gold
Gold is a chemical element with the symbol Au and an atomic number of 79. Gold is a dense, soft, shiny, malleable and ductile metal. Pure gold has a bright yellow color and luster traditionally considered attractive, which it maintains without oxidizing in air or water. Chemically, gold is a...
and wheat.
Risks
The main exposure is to Market riskMarket risk
Market risk is the risk that the value of a portfolio, either an investment portfolio or a trading portfolio, will decrease due to the change in value of the market risk factors. The four standard market risk factors are stock prices, interest rates, foreign exchange rates, and commodity prices...
as the warrant will be profitable only when the market price exceeds the strike price for a 'call warrant' or is below the strike for a 'put warrant'. The inherent leveraging effect of the warrant significantly increases the risks and traders that are using warrant to speculate can make or lose significant sums very quickly. With covered warrants the maximum loss is limited to the price paid for the warrant (ask or offer price) plus any commission or other transaction charges. Thus, although warrants are classed as high risk they are not as risky as other investment products such as contracts for differences
Contract for difference
In finance, a contract for difference is a contract between two parties, typically described as "buyer" and "seller", stipulating that the buyer will pay to the seller the difference between the current value of an asset and its value at contract time...
or spread betting
Spread betting
Spread betting is any of various types of wagering on the outcome of an event, where the pay-off is based on the accuracy of the wager, rather than a simple "win or lose" outcome, such as fixed-odds betting or parimutuel betting. A spread is a range of outcomes and the bet is whether the outcome...
in which an investor would have to pay for future losses.
Another aspect of risk is that an investor could lose their entire investment if the corporation issuing the warrant becomes insolvent.
See also
- Warrant (finance)Warrant (finance)In finance, a warrant is a security that entitles the holder to buy the underlying stock of the issuing company at a fixed exercise price until the expiry date....
- Option (finance)Option (finance)In finance, an option is a derivative financial instrument that specifies a contract between two parties for a future transaction on an asset at a reference price. The buyer of the option gains the right, but not the obligation, to engage in that transaction, while the seller incurs the...
- Derivative (finance)Derivative (finance)A derivative instrument is a contract between two parties that specifies conditions—in particular, dates and the resulting values of the underlying variables—under which payments, or payoffs, are to be made between the parties.Under U.S...
- Contract for differenceContract for differenceIn finance, a contract for difference is a contract between two parties, typically described as "buyer" and "seller", stipulating that the buyer will pay to the seller the difference between the current value of an asset and its value at contract time...