Warrants are speculative instruments listed and traded as options on the JSE. Their value is mainly dependent on the underlying share or index over which they are listed. The starting point for anyone wanting to trade them, as an alternative to trading in shares, is to determine their time horizon and your own appetite for risk. Warrants in South Africa are usually listed for a period of six to eight months, after which they expire. This makes it necessary for your trading to be more precise, from a timing point of view, than when purchasing an ordinary share.
Who is suited to trade warrants?
Not everyone. Warrants are geared because they offer the trader a greater potential return than ordinary underlying shares. Assuming the share over which a warrant is listed rises 5%, you could achieve a return of 15% to 30% on the warrant.
On the flip side, if the share drops 5%, you could lose the same amount. This is why it is vital to understand the product and adhere to your stop loss.
Why are traders looking to the warrant market?
The main reason is because they know the maximum amount of money that can be lost when they enter a trade. If you were to buy a warrant at 30 cents, the maximum you could lose is 30 cents, even if the share over which it was listed fell from R100 to zero. When it comes to trading single stock futures (SSFs) or contracts for difference (CFDs), traders can lose far more than they initially invested.
What types of warrants are available?
There are two types available for speculators to trade: call warrants enjoy the bulk of the trade, while put warrants are supported by the “bears” that are found in every market. If you think a share is undervalued, buy a call warrant. As the price of the share rises, so will the price of the call warrant.
If you are bearish, buy a put warrant. If the share price over which the put warrant is listed starts to fall, the put warrant will gain in value. Put warrants therefore have an inverse relationship to the performance of the share price.
What are the advantages of trading warrants?
- They are a low-cost entry into trading blue chip stocks. Being able to buy 2 000 Anglo American shares requires a capital outlay of around R500 000. Warrants allow you to replicate that at approximately 20% of the cost.
- When buying a warrant, the maximum you can lose is the premium that you pay for the warrant. Thus, if you buy 100 000 warrants at 30c the capital outlay is R30 000 – this amount is the maximum loss you can incur.
- Warrants effectively allow a small trader to short the market. If you think a share is overvalued, you have an instrument (put warrant) that appreciates when thay
- Share falls.
- Liquid markets with tight spreads are made by the various banks that create these products. The tighter the spread, the easier it makes getting in and out of a position.
All the major banks act as market makers in warrants. Standard Bank’s Online Share Trading Platform is a very efficient broker platform, offering many benefits for warrant traders. The bank also offers educational seminars and online warrant tutorials.
For more information, log onto www.warrants.co.za.
Warrants are one of a number of geared instruments available to the retail investor in South Africa, but it’s wise to ensure you are properly educated before you start to trade in any of them.