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Ten years on, market warrants another look

AUSTRALIA’S warrants market celebrates its 10th birthday this year, in good health and once again growing rapidly after the setback of 1999 and 2000.

The warrants market caters for a wide range of investors, though turnover is dominated by speculative traders. Not that this should not deter the more conservative from using warrants to diversify their portfolio, boost returns or manage risk.

The prominence of speculative traders accounted for the steep slide in market turnover in 1999 and 2000 as traders turned their attention to “tech” stocks. Now traders are returning to the warrants market and turnover is growing strongly.

In the first three months of the year, 2.8 billion warrants valued at $708 million were traded on the ASX.

In broad terms, there are two types of warrants, trading and investment.

Trading warrants include equity, index and currency warrants, and are designed for traders wanting to speculate on short-term price movements in individual stocks, stock indices or currencies.

Investment warrants include endowment and instalment warrants. They are generally longer dated, carry lower risk and offer lower returns than trading warrants.

All warrants are listed on the ASX and the process of buying and selling warrants is essentially the same as trading in shares. There are currently more than 600 different warrant series and about 15 active issuers.

The issuers are financial institutions such as ANZ Bank, Citibank, Macquarie Bank and Societe Generale.

For many traders, the principal attraction of warrants is the ability to achieve leveraged returns. Small percentage changes in the underlying instrument (eg Telstra shares) result in larger percentage changes in the value of the warrant. This is because buying the warrant involves a smaller monetary outlay than buying the underlying shares outright.

The leverage effect works both ways. It can mean big percentage gains if all goes well, but it can also mean big percentage losses. Importantly, the downside risk is limited to the initial outlay, whereas other forms of leveraged investment, notably futures, can result in losses bigger than the initial outlay. Also, holders of warrants do not have to worry about margin calls, unlike people who use futures, options or margin loans to achieve leverage.

Warrants enable investors to gain exposure to broad market movements. For instance, investors can buy warrants over indices such as the S&P/ASX 200. Similarly, basket warrants enable investors to profit from movements in the price of a selected basket of stocks (see right).

Another benefit of warrants is protection of a share portfolio. By purchasing a put warrant, investors can lock-in a selling price for the underlying security for the life of the warrant. This is like taking out insurance against a falling share price.

In this respect, standard call (buy) and put (sell) warrants are very similar to options. In both cases, the holder acquires a right to buy or sell the underlying security at an agreed price during a specified period.

l Next week: Trading and investment strategies in the warrants market.

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