Podcast: Understanding warrants, carefully

Simon BrownJSE Direct, Latest

Simon Shares

  • Day 63 of lockdown, level 3 on Monday. As I record we’re still waiting for details as to what is allowed under level 3, but it seems that rather than saying what we can do, the regulations will tell us what we can’t do and that list will be short. We will be able to exercise, retail is open but restaurants and bars not. Alcohol will be sold, but not tobacco products. Personally I will pretty much stay in lockdown (aside from my daily radio show), but now with a drink.
  • NYSE trading pit opened again on Tuesday. A throwback to the days before technology but always fun to watch, not that I have been to the NYSE. I did see the JSE in the mid 80’s on a trip to Johannesburg. It was wild and made no sense to me but it was energetic and I wanted to be a part of it all.
  • Famous Brands* (JSE code: FBR) results presentation made two comments “restaurant landscape will be irrevocably transformed” because of Covid-19. The market recovery in the casual dining segment will be “slow and unforgiving”.
  • Woolies (JSE code: WHL) trading date shows food doing well but clothing and Australia doing very poorly. They’re talking to bankers in Australia about debt covenants and Australia may need a AU$100million cash injection.
  • Solid Coronation* (JSE code: CML) results with HEPS and dividend both up 8%. But risks remain, will private investors pull money or slow/stop deposits? Also as companies reduce head retirement money flows into their funds ever month. Tuesday in parliament Minister Dlamini-Zuma said unemployment may hit 50% and the Absa (JSE code: ABG) said they expect local 2020 GDP to be -10%.
  • Pepkor (JSE code: PPH) saw R5.5billion in lost revenue due to COVID-19 already so far. R476million to end March and another R5billion in April. May has seen a spike in shopping so they’ll get some back, but likely not all.
  • FAANG annualised returns since the lows of March is averaging 970%. Wowzer, but as I said last week; don’t fight the Fed.

* I hold ungeared positions.

Upcoming events;

Understanding warrants

Warrants were the first derivative I traded, starting in October 1997 as they were launched in South Africa. SAWarrants was also my first successful website that launched me into the financial services industry. Recently I’ve been trading some warrants again as have a few traders I know and a tweetstorm I did over the weekend got a lot of question about trading warrants.

The short answer is don’t.

They’re derivatives and hence risky If you’re an ETF buyer or even just a straight equity buy and holder, stay away. If you’re successfully trading other derivatives then they’re worth a look. Certainly, they have some benefits over traditional derivatives, but also lots of complexity.

A warrant is really an option that gives the holder the right to buy or sell an underlying asset.

  • Call goes up as does the underlying asset.
    • Last letter of the warrant code will be A-0.
  • Put goes up as the underlying asset falls.
    • Last letter of the warrant code will be P-Z.

The fact that it is a right, not an obligation, means your loss is capped at what you paid.

Warrants trade on the JSE just like any other share or ETF with six-letter codes. First 3 letters denote the underlying asset. 4th letter is the issuer, 5th letter the style (B for normal, I for instalment and K for knockout – be very careful of knockout warrants). The last letter is as above denoting call or put.

But a lot of greeks that can trip you up that are outputted by the Black-Scholes formula (this formula won the writers a Nobel prize).

  • Gearing ~ amplification of the move. For example, 4x gearing means for every 1% move of the underlying your warrant will move 4%. You don’t want to gear much more than 5x, 8x on indices.
  • Theta ~ time decay. A warrant decays every day, every week, even if the asset moves in your direction it will lose some value. This reduces the warrant price and is very aggressive in the last third of the warrants life. Be very careful of tie decay.
  • Expiry ~ unlike CFDs, warrants expire and if you hold at expiry you’ll be paid out. If it has value.
    • Make sure you have lots of time, at least 3 months, ideally 6 months. Time decay becomes very aggressive in the last few months.
    • Value is price above strike price at expiry (for calls). For puts price below strike.
  • Strike is the price at which you can buy / sell the asset.
    • You want the current price to ideally be 10% – 15% of the strike price.
  • Delta ~ many things but more or less the likelihood the warrant will expire with value.

One major benefit is that with warrants you can only lose hat you paid, unlike with CFDs or futures you can lose more than you deposited.

The warrant issuers will also ensure there is a market maker buying and selling at fair value at all times. They will use a pricing matrix that can be found online.

If you trade warrants within a Standard Online Share Trading warrant account you pay flat brokerage of R50 +taxes.

And Standard Bank have a good website at warrants.co.za

And I will end where I started. Be very careful and do not jump into warrants unless you’re a successful trader already, otherwise, the greeks will get you. The big challenge is that you may get the direction of the trade right (call or put) but pick the wrong warrant and lose money.

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JSE Direct is an independent broadcast and is not endorsed or affiliated with, nor has it been authorised, or otherwise approved by JSE Limited. The views expressed in this programme are solely those of the presenter, and do not necessarily reflect the views of JSE Limited.

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