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Overview of Derivative Warrants

  1. Features of DWs
  2. Risk Involved in Trading DWs
  3. Other Aspects of Trading DWs
  4. Trading DWs on the SET
  5. Download DW Information Leaflet

Features of DWs

Features of DWs: What Are Derivative Warrants?

What Are Derivative Warrants?
    Derivative warrants are an instrument that gives an investor the right to “buy” or “sell” an underlying asset at a pre-set price (exercise price) at a specified expiry date. They may be bought and sold prior to their expiry in the market. At expiry settlement is made in cash rather than a purchase or sale of the underlying asset. Derivative warrants are issued by third party, independent of the issuer of the underlying assets. Derivative warrants traded in Thailand normally have an initial life of three to nine months. Each derivative warrant is likely to have a unique exercise price and expiry date.

Types of Derivative Warrants
    Derivative warrants are generally divided into two types; calls and puts. Holders of call warrants have the right, but not obligation, to purchase from the warrant issuer a given amount of the underlying asset at a predetermined price (also known as the exercise price) within a certain time period. Conversely, holders of put warrants have the right, but not obligation, to sell to the warrant issuer a given amount of the underlying asset at a predetermined price within a certain time period. In Thailand derivative warrants are settled in cash when they are exercised at expiry. In fact most derivative warrants are sold by their holders prior to their expiry dates.

How do Derivative Warrants Work?
    Those who buy call warrants usually hold a bullish view of the price of the underlying asset. To profit from the purchase of a call warrant the holder of the warrant may sell the warrant in the market or wait until the expiry date. At the expiry of a call warrant, if the price of the underlying asset as calculated under the terms of the derivative warrants is higher than the derivative warrant’s exercise price, the call warrant will be exercised and the holder will be entitled to the difference in cash. The cash amount will be equal to the positive difference between the closing price of the underlying asset and the exercise price of the derivative warrant adjusted by the conversion ratio. The closing price of the underlying asset is calculated by a formula described under the “Settlement Price” section below. If the price of the underlying asset at expiry is less than the exercise price the derivative warrant will expire worthless.

    Conversely, those who buy put warrants usually hold a bearish view of the price of the underlying asset. Like the call warrant, the holder can sell the put warrant in the market or wait until expiry. At the expiry of a put warrant, if the price of the underlying asset as calculated under the terms of the derivative warrant is lower than the derivative warrant’s exercise price, the put warrant will be exercised and the holder will be entitled to the difference in cash. The cash amount will be equal to the positive difference between the exercise price of the derivative warrant and the closing price of the underlying asset adjusted by the conversion ratio. If the price of the underlying asset at expiry is higher than the exercise price the warrant will expire worthless.

 

Features of DWs: Factors Determining the Price of a Derivative Warrant


Factors Determining the Price of a Derivative Warrant
Some major factors that affect the theoretical price of a derivative warrant include:
  • The price of the underlying asset and the strike price
  • The volatility of the underlying asset
  • The time remaining to expiry
  • Interest rate
  • The expected dividend payments on the underlying asset

    Like other securities, the price of the derivative warrant may also be affected by
the supply of and the demand for the derivative warrant itself. Various mathematical formulae are used by market players to calculate the theoretical prices of derivative warrants and those theoretical prices often differ from market prices.

Intrinsic Value and Time Value
Theoretically, the price of the derivative warrant before expiry consists of two components: intrinsic value and time value.

    The intrinsic value of a derivative warrant is the difference between the price of the underlying asset and the exercise price of the derivative warrant. A call warrant is said to be in-the-money if the underlying asset price is above the exercise price and said to be out-of-the-money if the underlying asset price is below the exercise price. Similarly, a put warrant is said to be in-the-money if the underlying asset price is below the exercise price and said to be out-of-the-money if the underlying asset price is above the exercise price. A derivative warrant is said to be at-the-money if the underlying
asst price is same as the exercise price.

    The time value of a derivative warrant is the difference between its current price and its intrinsic value. An out-of-the-money warrant with no intrinsic value has only
time value. The time value of the derivative warrant decays over time and falls to zero at expiry of the derivative warrant.

 

Features of DWs: Volatility

    Volatility is an important component in determining the time value of a derivative warrant. Volatility is a measure fluctuation in the price of the underlying asset. The higher the price fluctuation the greater the potential for the derivative warrant to trade in-the-money. There are two types of volatility: historical volatility and implied volatility. Historical volatility is a measure of how the underlying asset price behaved in the past. Implied volatility is derived from the current price of the derivative warrant and indicates the market perception of how volatile the underlying asset price will be over the remaining life of the derivative warrant.

Turnover

    High turnover in a derivative warrant should not be regarded as an indication that
its price will go up. As mentioned, the price of a derivative warrant is affected by many factors from market forces to technical matters such as the price of the underlying asset, the volatility of the price of the underlying asset, the time remaining to expiry, interest rate and the expected dividend on the underlying asset.


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Risk Involved in Trading DWs

    Derivative warrants trading involves high risks and is not suitable for every investor. Investors should understand and consider the following risks before trading in derivative warrants:

Issue Risk
    Derivative warrant holders are unsecured creditors of an issuer and they have no preferential claim to any assets an issuer may hold. Therefore, investors are exposed
to the credit risk of the issuer.

Gearing Risk
    Although derivative warrants may cost a fraction of the price of the underlying assets, a derivative warrant may change in value more or less rapidly than the underlying asset. In the worst case the value of the derivative warrants falls to zero and holders lose their entire investment amount.

Limited Life
    Unlike stocks, derivative warrants have a expiry date and therefore a limited life. Unless the derivative warrants are in-the-money, they become worthless at expiration.

Time Decay
    One should be aware that other factors being equal, the value of derivative warrants will decrease over time. Therefore, derivative warrants should never be viewed as products that are bought and help as long term investments.

Volatility
    Other factors being equal, an increase in the volatility of the underlying asset should lead to a higher warrant price and a decrease in volatility lead to a lower warrant price.

Market Forces

    In addition to the basic factors that determine the theoretical price of a derivative warrant, derivative warrant prices are also affected by all other prevailing market forces including the demand for and supply of the derivative warrants. Supply and demand forces may be greatest when a derivative warrant issue is almost sold out and when issuers make further issues of an existing derivative warrant issue.


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Other Aspects of Trading DWs

Leverage
    Derivative warrants usually cost a fraction of the price of the underlying assets, yet the value of a derivative warrant may increase or decrease to a much greater extent than the changes in the price of the underlying asset. This means greater potential profit compared to trading in the underlying asset and also the risk of losing the entire purchase price of the derivative warrant.

Limited Maximum Loss

    Although derivative warrants can potentially multiply both gains and losses, the maximum loss to warrant buyers is limited to the initial amount paid for the derivative warrants.


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Trading DWs on the SET

How to Read the Ticker of a Derivative Warrant
    Derivative warrants listed on the Exchange can be identified by the ticker which indicates some of the basic features of the derivative warrant.

Liquidity Providers for Derivative Warrants
    Derivative warrant issuers are required to appoint a liquidity provider for each one
of their listed derivative warrant.

Trading Arrangements

    Similar to other cash market products, derivative warrants are traded on the Exchange’s Automatic Order Matching System during trading hours in multiples of board lots and settled on T+3. Investors should note that the expiry day of a derivative warrant is not the same as the last trading day. To ensure that a trade executed on the last trading day has sufficient time for settlement and registration, there shall be 4 settlement days between the last trading day and the expiry day. Investors can only trade the derivative warrant on or before the last trading day.


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