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 THE ABC OF... |
Warrants
Warrants a mention
CS journalists
If you like the sound of warrants and you're eager to learn more, we've come up with four points that warrant a mention.
1. Time decay
Traders beware: warrants become less valuable as they approach their expiry date, often declining rapidly in the last third of their life. Time decay happens regardless of what's happening to the underlying share price, which means that buying a warrant close to its expiry date is a risky practice indeed. And if the warrant happens to be "out of-the-money" (see below) at expiry then too bad, the warrant expires worthless.
If the opportunity for a profit is looking sketchy towards the end of your warrant's life, you're better placed cutting your losses and preserving capital - possibly even switching to longer-dated warrants if your strategy permits - rather than hanging on to the bitter end.
2. "In the money" and out of the money
If you want to trade warrants, then be prepared to learn the lingo.
A call warrant is in-the-money when the underlying share price is greater than the warrant's exercise price, and "out-of-the-money" when the share price lags the exercise price. You use a call warrant when you are bullish on the outlook of a share.
A put warrant is "in the money" when the underlying share price is below the warrant's exercise price, and "out of the money" when the underlying share price is above the exercise price. You use a put warrant when you are bearish on the outlook of a share.
And lastly, a warrant is "at the money" when the underlying share price equals the warrant's exercise price.
A warrant has intrinsic value - which is the difference between the warrant's exercise price and the underlying share price - when it is "in the money." Intrinsic value is always quoted as zero and above.
3. Summing up a warrant
When summing up a warrant, remember to consider the following important points: How much income in the form of dividends and franking credits do you expect to receive? What sort of capital gain do you estimate receiving? What rate of interest are you paying to the issuer? What are the other transaction costs - such as brokerage and borrowing fees? What tax rate are you on, and are the tax savings beneficial?
4. Unlocking cash
A handy strategy for anyone dreading the day they'll have to pay capital gains tax on their shares ia to convert your shares into instalment warrants instead. By doing this you can unlock some cash that can be invested elsewhere, while maintaining similar exposure to your existing shares.
To check out the range of warrants brokers available go to our warrants brokers comparison tables.
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