STOCK MARKET: WHY AND HOW TO INVEST IN WARRANTS
Warrants allow sophisticated investors to boost their portfolio. Café de la Bourse presents the mechanism of these stock market products and provides you with these tips for investing successfully in these risky but potentially profitable products.
THE CHARACTERISTICS OF THE WARRANT, A SECURITY LISTED ON THE STOCK EXCHANGE
A Warrant is a security listed on the stock exchange which gives the right (and not the obligation), to buy (it is then a Call Warrant) or to sell (it is then a Put Warrant) a determined underlying, at a price fixed in advance (called the strike price) until a maturity date (or maturity).
Products issued by banks, with many possibilities for the underlying
Warrants are stock market products issued by banks, based on many underlying assets such as French and foreign stocks, indices, currencies or even commodities (these are indeed derivatives). The underlying asset can, therefore, take many forms. Société Générale, for example, offers a range of Warrants on more than 260 different underlying.
Warrants: securities listed on Euronext
Warrants are securities listed on Euronext Paris and therefore tradable as a single share. They can, therefore, be bought and then sold before their expiration. Listed continuously on the Paris Stock Exchange, transactions involving Warrants are carried out through a traditional financial intermediary: bank or broker.
Warrants are listed products, such as stocks, bonds or certificates.
Warrants: leveraged stock market products
With the Turbos and the Leverage and Short Certificates, the Warrants form the category of leveraged stock market products.
Warrants are indeed stock market products that incorporate leverage. This is also the main interest and the main risk of the Warrants. The leverage effect allows for much wider variations in the Warrant than its underlying. That is to say that when the price of the underlying varies by 1%, the price of the Warrant may vary by 3, 4, 5 or much more.
Thus, Warrants can boost your portfolio: with a small amount of initial investment, you can play the upside or downside of the market while limiting your risk to the amount invested.
These are products reserved for informed investors because they follow and amplify the evolution of the underlying upward or downward, which can be favorable or unfavorable to the investor.
CALL AND PUT: DISTINCT STRATEGIES FOR INVESTING IN THE STOCK MARKET
Hedging or taking advantage of the downturn in financial markets with Warrants Put
Put Warrants allow you to cover your portfolio, you are immune to unfavorable market developments, at a lower cost.
Put Warrants also allow you to profit from a decline in the markets.
Indeed, we buy a Put Warrant when we anticipate the fall in the underlying. Thus, a Put Warrant allows, from the low initial investment, to benefit from downward leverage, by limiting your risk to the amount invested.
For example, if an investor has a CAC 40 equity portfolio and wants to hedge against a drop in this index, he can use a Warrant put on the CAC 40 index.
Similarly, if an investor wishes to bet on the fall of the CAC 40 index, a Put Warrant on the CAC 40 index is ideal.
A warrant put can effectively protect your portfolio or bet on the downturn in markets, but only temporarily. With leverage effects which can be significant, it is not a question of permanently keeping these products. Especially since you will also have to take into account the time value which mechanically reduces the value of the Warrant.
Take advantage of the rise in financial markets with Warrant Calls
Call Warrants allow you to benefit from the rise in stock, a currency, an index or a commodity.
Indeed, we buy a Call when we anticipate the rise of the underlying. Thus, a Call Warrant allows, from the low initial investment, to benefit from significant upward leverage, limiting your risk to the amount invested. For example, if you want to position yourself up on the CAC 40, you can use a Call Warrant on the CAC 40 index.
A Warrant Call temporarily boosts your portfolio. With leverage effects which can be significant, it is not a question of permanently keeping these products which are also largely impacted by the time value as we will see below.
USING A PUT WARRANT AND A CALL WARRANT: EXAMPLES AND TIPS
The Call Warrant to invest in ABC shares
Investing in the stock market on a Call Warrant: the investment objectives
Call Warrants are intended for investors anticipating a rise in prices on a given underlying. In this example, it will be the action of the company ABC.
Imagine that in February you anticipate the rise over a few months of the ABC share. Its share price is at this period of € 60. You buy 100. To benefit from leverage on your market idea, you choose to buy a Call Warrant. It gives you the right to buy the share at a fixed price of 80 euros (the exercise price) until a given date, December 30 (the deadline). You pay this right at its market price or 8 euros.
How to calculate the performance of a Call Warrant?
Favorable case: Let us admit that at the expiration, on December 30, the share of the company ABC is worth 100 €. Your Call Warrant gives you the right to buy it for only 80 €.
The call warrant is worth its intrinsic value at maturity, ie the positive difference between the price of the underlying and the exercise price, 20 euros (100–80). You bought this Warrant 8 euros, so you achieve a performance of +150% (you earn 20 euros for an initial investment of 8) for an increase in the action of +50%.
Unfavorable case: Despite your forecasts, the stock fell. It quotes only 40 euros on the expiry date of your Call Warrant which gives you the right to buy it at 80 euros.
The intrinsic value of your Call Warrant is zero. You have lost the entire amount invested, ie 8 euros per warrant, your risk is limited to the amount invested at the start. By playing the action live, you would have suffered the entire drop or 20 euros instead of 8!
Be careful however, this is only an example here because, in fact, we only keep a Warrant expiring very rarely. Indeed, it is not necessary to wait for the expiration of your Warrant hoping that it will have an intrinsic value to achieve again. A Warrant can pay off at any time, as long as you can sell it for more than you bought. In addition, you will benefit from the time value calculated in the price of the Warrant as you will see in the dedicated paragraph.
The Put Warrant to invest in the CAC 40 index
Investing in a stock exchange on a Put Warrant: the investment objectives
Put Warrants are intended for investors anticipating a fall in prices on a given underlying. In this example, it will be the CAC 40 index.
Imagine that in February you anticipate a drop over a few weeks of the CAC 40 index. It then rises to 4,000 points. To benefit from leverage on your market idea, you choose to buy a Put Warrant, a right to sell the CAC 40 index at a price set at 3,500 euros (the exercise price) up to a given date (or deadline), September 30. You pay this right at its share price, ie 250 euros.
How to calculate the performance of a Put Warrant?
Favorable case: Let us assume that at maturity, on December 30, the market fell according to your forecasts and the CAC 40 is now at 3,000 points. However, your Put Warrant gives you the right to sell it at 3,500 euros, or 500 euros above its current price.
The Put Warrant is worth its intrinsic value at maturity, ie the positive difference between the price of the underlying asset and the strike price: 500 euros (3,500–3,000). You bought this Warrant 250 euros, so you achieve a performance of + 100% (you earn 500 euros for an initial investment of 250) for a drop in the index of -25%. You benefited from downward leverage of 4.
Unfavorable case: Despite your forecasts, the index has remained stable and scores 4,000 points on the maturity date. The Put Warrant gives you the right to sell it for 3,500 euros. You have no interest in using this right.
The intrinsic value of your Put Warrant is zero. You have lost the entire amount invested, i.e. 250 euros per warrant, your risk is limited to the amount invested at the start, which is not the case with other leveraged strategies such as short selling (SRD and CFD for example).
Be careful however, this is only an example here because, in fact, we only keep a Warrant expiring very rarely. This product is indeed largely impacted by the time value as we will see below.
Time value and volatility: two factors that influence the value of a Warrant
Indeed, time counts for a lot in the value of a Warrant. When you buy a Warrant, whether it is a call or a put, you anticipate a movement of the underlying by the expiration of the Warrant. The further this deadline is, the more time you have to see your scenario come to fruition. Thus, the longer the maturity, the higher the time value of the Warrant and of course, the closer we get to maturity the lower the time value.
The volatility of the underlying also has a significant impact on the value of a warrant. In fact, the more the market anticipates high volatility, the more it expects large variations in the price of the value, upwards or downwards and therefore, more chances of winning with the Warrant. Therefore, the higher the volatility of the underlying, the higher the Warrants. Thus, the higher the volatility, the more the value of the Warrant increases because the more it is likely to hit the strike (strike price). This is why, when the implied volatility level increases (even without variation of the price of the underlying), the price of the Warrant increases. Conversely, when the level of volatility decreases, the price of the Warrant decreases.
So remember that, beyond the choice of the underlying, there are many criteria to take into account when choosing a Warrant. The issue price of the Warrant, then the price of each Warrant during its trading period (the price at which you will sell your Warrant before its expiration date) depends on the ratio between the level of the underlying asset and the strike price. , maturity (the time remaining before the maturity date), the value of the underlying, interest rates, estimated dividends and the level of volatility.
So choose a Warrant whose characteristics are adapted to market conditions and the scenario you are considering. Be careful when choosing a product at the strike price (the latter must be consistent with the current price of the underlying and the target price that you anticipate) and at maturity (it must always be farther than the horizon of your scenario). To be sure of making the right choice, check that the sensitivity of the Warrant price to variations in the price of the underlying (the delta coefficient) is between 30 and 60% for a Call Warrant, –30 and –60% for a put Warrant, to optimize leverage.
ADVANTAGES AND RISKS OF A WARRANT FOR INVESTING ON THE STOCK MARKET
The Benefits of Warrants Stock Products
Leverage but with limited losses
Warrants are stock market products that greatly facilitate the use of leverage compared to traditional solutions such as options and futures, because, unlike these products, Warrants allow you to invest with a risk of loss limited to the amount invested and not beyond. In addition, they allow you to invest with small amounts while a futures contract on the CAC 40 is currently worth around 55,000 euros.
Accessibility and transparency of the listing of a Warrant
In addition, the Warrants are easily accessible. To invest in the stock market in these financial instruments, you can use your classic securities account and your usual intermediary (bank branch, brokerage firm, online broker, etc.). In fact, all brokers and banks offer them while options and futures are only offered by a few specialized brokers.
You can place your stock market orders as simply as a share. Warrants are securities listed on Euronext Paris. The listing is continuous.
The various risks linked to Warrants
Warrants are stock market products intended for sophisticated investors who will understand their mechanism and understand the risks inherent in this type of investment.
Risk of capital loss
Warrants are products presenting a risk of capital loss. As a reminder, leverage works upwards as well as downwards, whether it is favorable or unfavorable to the investor. With a leverage of 3 for example, the gains if your anticipation are realized are multiplied by 3. Conversely, if the anticipations are not realized, your losses are also multiplied by 3. The investor is therefore exposed to a risk loss of the entire amount invested (but not beyond). In addition, this product has a lifetime with a decreasing time value. If your anticipation is not realized before the deadline, you lose all of your investment.
Leverage risks need to be managed with precision
Warrants are risky financial products. Therefore, consider using orders that allow you to master the execution. In addition, Warrants may experience large price fluctuations within the same session. So favor limit orders.
A possible exchange rate risk
In the case of an underlying in foreign currency, the price of the Warrant is also sensitive to variations in the exchange rate with the euro.