Friday, August 28, 2009

The Right Warrant

Warrant is a good instrument because of the leverage that you get. It is a quick path to become rich and also a quick path to become poor. That is why selecting the right warrant is very important. To trade in warrant, you need to have good skills in:
  1. Ability to red the trend of the mother share.
  2. Good timing (don't have to be perfect).
  3. Knows which warrant to buy.
Currently, there are a lot of warrants that have been issued. What I want to touch is how to compare the available warrants. I will use Axiata as an example as the comparison is the easiest. The figure belows shows my warrant calculator result for Axiata. There are 3 call warrants available: Axiata-CB, Axiata-CC and Axiata-CD.

If you have determined that the mother stock's trend is up, then you look at the call warrant.
The first criteria in selecting warrant is the exercise price. You want to buy something that is in-the-money or approaching the exercise price. Too far and the warrant gearing effect is muted. In Axiata case, all 3 warrants are in the money.

Next, you look at the expiration date. Too near and your warrant may not have the full potential to move along with the mother stock. Remember, a good trend may last 6 months to a few years. So, you want your warrant to go as far as it can with the mother stock. In Axiata case, all expires in Aug 2010 (with different dates). So, I consider them more or less equal.

The third criteria is to look at its premium. I look at the actual premium value and the percentage premium. For warrants that is out-of-money, the actual premium value is important as I can determine how much the price must move for it to be in-the-money. I look at the charts and determine whether there are any resistance (or support for put warrant) in the mother stock that will retrict the movement of my warrant. If all the warrants are in the money, then I look at the percentage premium. In Axiata case, Axiata-CC gives you the best value for money.

Lastly, I look at the simple gearing if everything else are equal. The higher the better.

I don't use Black-Scholes formula or any of the Greeks as I would like to keep my decision criteria as simple as possible. Furthermore, in a strong trending stock, this formula is not useful.

In Axiata case, I wonder what is going in the mind for those that bought Axiata-CC and Axiata-CD since Axiata-CB clearly gives you the best value. Maybe because Axiata-CB is more "expensive". Maybe the volume is generated by the market makers.

Anyhow, I hope that you get some ideas on how to choose warrants. If you are trading in warrants, why not try my Bursa Malaysia Warrant Calculator?

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