What are Warrants?
Warrants are an instrument which gives investors the right - but not the obligation - to buy or sell the underlying asset (e.g. a stock) at a pre-set price on or before a specified date.How many types of Warrants are there in the market?
There are two main types of warrants: subscription warrants and derivative warrants.
Subscription warrants are issued by a listed company and give holders the rights to buy the underlying shares of the company. They are either attached to new shares sold in initial public offerings, or distributed together with declared dividends, bonus shares or rights issues. Subscription warrants are valid between 1 and 5 years. Upon exercise, the underlying company will issue new shares and deliver them to the warrant holders.
Derivative warrants are issued by financial institutions. Unlike subscription warrants which must be call warrants, derivative warrants can be call or put warrants. Most of the derivative warrants in the market have a shorter life, ranging from 6 months to 2 years normally, although the current Listing Rules allow a maximum life of 5 years.
Warrants Major Risk
|Issuer risk||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 and other risks in relation to the issue.|
|Gearing risk||Although warrants may cost a fraction of the price of the underlying assets, a warrant may change in value to a much greater extent than the underlying asset. Gearing effect can work in reverse. A small change in the price of the underlying asset can lead to a substantial decline in the warrant price. In the worst case, the value of the derivative warrants may fall to zero and holders may lose their entire investment amount.|
|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.|
|Limited Life||Unlike stocks, warrants have an expiry date and therefore a limited life. Unless the warrants are in-the-money, they become worthless at expiration. Deeply out-of-the-money warrants are less sensitive to movements in the price of the underlying asset because such warrants are unlikely to become in-the-money on expiry.|
|Time Decay||One should be aware that so long as other factors remain unchanged the value of warrants will decrease over time. Therefore, warrants should never be viewed as products that are bought and held as long-term investments.|
|Market forces||In addition to the basic factors that determine the theoretical price of a warrant, warrant prices are also affected by all other prevailing market forces including the demand for and supply of the warrants. This is particularly so when a warrant issue is almost sold out and when issuers make further issues of an existing warrant.|
What is CBBC?
Like derivative warrants, CBBC are structured products. They are leveraged investments that track the performance of the underlying assets without requiring investors to pay the full price required to own the actual assets. They are issued either as Bull or Bear contracts, allowing investors to take bullish or bearish positions on the underlying assets.
CBBC may be issued with a lifespan of 3 months to 5 years and are settled in cash only. CBBC are issued with the condition that during their lifespan they will be called by the issuers when the price of the underlying assets reaches a level (known as the Call Price) specified in the listing document. If the Call Price is reached before expiry, the CBBC will expire early and the trading of that CBBC will be terminated immediately. The specified expiry date from the listing document will no longer be valid.
What are the characteristics of CBBC?
CBBC can be divided into two categories: Bull Contracts and Bear Contracts. If investors take bullish position on the underlying asset, then choose Bull Contracts; if you take a bearish position, you can choose Bear Contracts.
CBBC have a mandatory call mechanism, that is, if the underlying asset's prices reach the call price, the issuer must then call the CBBC. The residual value depends on the categories of CBBC, which are namely category N CBBC and category R CBBC.
A Category N CBBC refers to a CBBC where its Call Price is equal to its strike price, and the CBBC holder will not receive any cash payment once the price of the underlying assets reaches or go beyond the Call Price.
A Category R CBBC refers to a CBBC where its Call Price is different from its strike price, and the CBBC holder may receive a small cash payment (called "residual value") upon the occurrence of an mandatory call event but in the worst case, no residual value will be paid (Category N CBBC do not have residue value).
CBBC Major Risk
|Issuer risk||CBBC investors are considered unsecured creditors and cannot lay any preferential claim to assets held by the securities' issuer. So, if a CBBC issuer becomes insolvent and defaults on its listed securities, holders of such contracts may lose their entire investment. When choosing a CBBC, investors are advised to check the financial capability and credit worthiness of the issuers.|
|Gearing effects||CBBCs are a type of derivatives that uses leverage to amplify the pricing fluctuation of the underlying assets. If an investor predicts wrongly the price trend of a CBBC's underlying asset, he or she may suffer substantial losses of up to the entire invested amount.|
|Mandatory Call Mechanism||When the call price is reached, the issuer will call the CBBC. Trading stops and the settlement process starts. Even if the underlying asset bounces back in the right direction, such a CBBC will not resume trading.|
|Expiry Time Horizons||CBBCs have expiry dates after which they become worthless. For long term investing, Investors should pick those with longer lifespans or sustainability. If you are holding a CBBC expiring in a relatively short time, consider selling earlier or switching to one with similar characteristics but a longer lifespan.|
|Interest Rates||Interest rate fluctuations will have an impact on CBBC pricing. In theory, an interest rate uptrend will raise the pricing of bull contracts but impact negatively on that of bear contracts. Having said that, unless interest rates become very volatile or the investor holds a large inventory, the impact of rate changes is less than some other market factors on CBBCs.|