| Risks in trading structured warrants |
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| Market risk |
The market value of a warrant is susceptible to events that affect its demand and supply. If the price of the underlying shares falls below the exercise price at the maturity date of the warrants, then the warrant holders will sustain losses in their investments. For illustration, a call warrant carries an exercise price of RM20 and it costs RM1.50 per warrant. Each warrant enables the holder to purchase the warrant at exercise price. Given the market price of the stock at the end of maturity is RM15, a holder of one warrant will have to bear a RM1.50 investment loss.
The formula for calculating:
Exercise price of stock (RM20) + Cost of warrant (RM1.50) = RM21.50 (Full settlement price)
Market price of stock at maturity date of warrant = RM15
Since the settlement price is higher than market price, warrant investors will have to bear a RM1.50 loss for each warrant held. |
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| Credit risk |
| Credit risk is the risk that the warrant issuer will not be able to fulfil its obligations (i.e. to access the credit rating of the warrant or the performance guarantee of its holding company) on the exercise of the warrant. To prevent this risk, investors must take the initiative to assess the credit risk associated with the warrant issuer. |
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| Limited life of warrants |
| Warrants have expiry dates and as time passes, the time value of warrants decreases. Assuming all other things being equal, the more time there is left before expiry, the greater the chance that the warrant will become profitable through a favourable move in the future. When a warrant is about to expire, it has no time value. Warrants may expire before an investor’s expectation is realised, making them worthless. The maturity period of the warrant is fixed and cannot be extended. Hence, investors must select a warrant that has sufficient time to match their expectations. |
As a smart investor, you need to pay attention to the investment product’s characteristics and benefits and most importantly, risks before investing. At the end of the day, the same applies to structured warrants.
