Warrants vs. Options vs. Other Instruments

[Spiker212]

Just joined this forum and look forward to future input.

It seems to me that the traders talk about making real money by trading derivative type products rather than the actual stock. My previous attempts at trading warrants has had mixed results due to an inability to trade during the day while working a full time job - I found it very difficult to time entry and exit.

As a result I have limited my trading to shares - movements are generally more orderly and I can buy sell after hours. Results however are not spectacular - I certainly am not loooking to give up my day job and live of trading profits. I hope to learn a better trading strategy while participating in this forum.

My question then - are any of the traders in this forum making real money by trading the mother stock or should I seriously educate myself on using warrants or options?

Secondly, what are your preferences over warrants or options as a derivative product?

 

[tech/a]

Re: Warrants/Options v Mother Stock?

Serious money can be made but undercapitalization will get the majority everytime.
Hence the lure of the leveraged instrument.
Serious money to some may not be serious to others.
Consistent money regardless of quantity is more important.

 

[Fab]

Warrants vs Options

I am looking at this products to take a bit of a bet on some stocks. Can anyone explain the difference between Option and Warrants and maybe advise of soe good ones and why ?

 

[professor_frink]

Re: Warrants vs Options

I am looking at this products to take a bit of a bet on some stocks. Can anyone explain the difference between Option and Warrants and maybe advise of soe good ones and why ?

hi fab, I hope that's just a figure of speech, because if you just want to have a "bit of a bet", you should probably go to the casino and stay away from options and warrants(especially options). Have you had any experience trading in normal shares before? If not, it would be a good idea to start there before tackling derivatives.
Don't want to come across too harshly, but there is nothing worse than losing money going long in a bull market. Trust me, I know from personal experience

 

[Fab]

Re: Warrants vs Options

INdeed it was a figure of speech. I have been trading share for over 6 years now and also traded warrants but lost some money on warrants therefore I believe they are few things I don't understand about them like the volatility factor.
I have never traded options

 

[wayneL]

Re: Warrants vs Options

INdeed it was a figure of speech. I have been trading share for over 6 years now and also traded warrants but lost some money on warrants therefore I believe they are few things I don't understand about them like the volatility factor.
I have never traded options

Fab

Here is a PDF put out by the ASX to explain the difference:

http://www.asx.com.au/markets/pdf/DiffOptWnts.pdf

That's enough to start with, and there are further differences, which are also mentioned at the ASX site. There are even differences between different types of warrants.

Which is better depends entirely on what you want to achieve, so that is perhaps the first question.

Cheers

 

[GreatPig]

Options vs Warrants

Just dragged out some old books I've got (from more than 20 years ago) on futures and options, as I want to start reading up on all that stuff again. Also interested in finding out more about warrants, which weren't around then (AFAIK).

I'm looking to possibly start adding these to my trading and perhaps investment strategies. While I want to read up on futures again, I probably wouldn't start trading them, so am mostly interested in options and warrants at this stage.

For warrants, the main source of info I've got at the moment is the ASX website. Any other good sites for these? Any particularly good books worth buying?

For my investment portfolio, I may start looking at installment warrants (when the time is right), but for now, I mainly want to compare trading warrants and options.

So for the standard sort of trading call and put warrants, how do they compare to trading options? What are the main differences between them, and the advantages and disadvantages of each? How do they compare in terms of liquidity and costs (ie. brokerage & fees)?

And while I'm not especially interested in CFDs right now, comparisons with them would also be helpful.

Any info appreciated.

Thanks.

GP

 

[wayneL]

Re: Options vs Warrants

Hi GP

If you just want to buy and sell put and calls, then there are pros & cons for each. I don't know enough about the OZ market to give an opinion either way.

But one notable difference is that you cannot short warrants, and therefore you cannot create strategies outside of a pure directional play. This throws the balance way in favour of options.

It might not be something you would think of doing straight away (different strategies that is) but as you learn more, the extra flexibility is fantastic.

 

[markrmau]

Re: Options vs Warrants

GP, I am not an expert in this area, but this is my understanding:

1. Installment warrants are a good way to obtain leverage. You can get call warrants from ABN Am. charging 7.5% interest or so with delta pretty close to 1. ABN makes a good market.

2. I suggest that the trading warrants are NOT as good as buying options as the market buyer is less sophisticated than options players so you end up paying more for the same thing.

3. My biggest gripe is the .5c. Take BBI warrants for example. BBI @ 1.55 allows you to trade at .5c increments. But the warrants always trade at 1c increments to the MM's advantage.

Then consider 4:1 warrents etc. This allows the MM to screw you even more.

CFD's: Interest charged at current market value so it really is for short term swing trades.

 

[cuttlefish]

Re: Options vs Warrants

Have recently started dabbling in options after many years of far more conservative value based investing, I'm learning that there's a lot to learn.

I chose options as a vehicle for getting more leverage mainly because they seemed like an easy thing to enter, and the risk is limited to the premium if just buying calls and puts.

I was starting to get a bit annoyed with getting knocked around by things like time decay and volatility (I understood time decay to a fair extent, but didn't really understand how volatility works - I suspect its one of the first options 'gotchas'). But I'm also starting to realise that once you understand these things they can be used to advantage (not that I'm necessarily achieving that yet but I'm looking over past situations and realising how I should have done things differently.).

I was starting to think about looking into cfd's or warrants but think I'll stick with the options now that I'm starting to understand them a little.

Liquidity in the secondary stocks where the market makers aren't required to provide a spread is probably the main drawback that I've noticed about options - but I imagine there'd be similar issues with the other instruments as well.

The discussion in the options mentoring thread on here is a good read.

 

[RichKid]

Re: Options vs Warrants

Hi GP,

On Warrants:

I've had similar thoughts and dabbled a bit in it over the last two years or so. I'm a novice so read the following with a very cricitcal eye.

First word is: BEWARE!

Always read the pds for the particular instrument to check the terms and vital stats. The ASX has a good search facility for warrants, you can click straight through to the pds.

Apart from pricing considerations I find that each warrant has its own personality- depends on the market maker. Some have wide spreads others have narrow ones, some will fill if you place an order bw the spread others wont. Depending on your strategy you may not even find a warrant that suits, our markets are not that liquid. Often only the series nearest to the exercise price will be 'alive' (ie have a market), especially for the smaller stocks.

I find that because the minimum parcel is as low as $500 you can trade them as a trial without losing much, unlike some options where you'll be paying much more to buy even one contract (eg BHP, NCM), also there is often some sort of market in most warrants, not always the case with eto's- but that's mainly for the lesser stocks. The tnxn costs are also lower as it's just the cost of a share trade (options trading commissions are higher)- no ACH fees per contract either.

It's good for pricing when there are many mm's offering similar warrants but they make minor changes to the terms to make it difficult to compare their value directly (eg conversion ratio or exercise price or expiry date). Worth watching the warrants for a week or so to see how it behaves. I mainly use them for short term swing trades, especially for shorting, so as Wayne says you are limited, similar to a share trade but with leverage- that's what I use it for, trades only last a few days on average, I'd normally get stopped out in a day or two so timing is important to get filled correctly, small position go without saying since they are volatile, unless you get some that are deep ITM, similar story to options I guess.

Unlike options your orders don't expire eod, that may be a negative as well if you are dealing with a volatile stock.

I'd hate to be buying warrants in order to exercise them unless you've really done your homework on it's true value and conversion ratios.

Also see the issuer sites (for the pricing matrix) which are mentioned on the ASX website. Note that the matrices are merely guides, described as 'marketing collateral' rather than anything else, note the delta, they are not obliged to provide the matrices.

The resources below will help.

1) Worked examples in Harper's 'Derivatives in a Nutshell' and 'Speculating on the Australian Stock Market (2ed)' (both Excellent imho).

2) www.ozwarrants.com.au

3) Wendy Newtons's 'Warrants for Equity Investors' for a slightly outdated overview of different warrant types.

4) The free asx booklet on warrants (in pdf on their site).

5) Subscribe to the ASX Traders newsletter, they have some warrants articles/ideas from time to time as do the warrant sections of the big mm's (and Egoli too).

6) Contact the major Instalment warrant providers for their long dated series (Westpac, Macquarie UBS etc) pds's to compare their pricing strategies.

7) Material on option pricing and volatility in this forum (especially Wayne's early threads) will take a lot of the mystery out of the price movements, you will learn to hate the mm's with a passion.

I hope you do better than I have!! When properly constructed these strategies should yield some great results, the mm's will skim some profits but you can still do well imo but it takes discipline. Do some strictly regulated paper trading first, maybe post trades live/eod for comments. The spread moves fast at times so you may have trouble fixing a price.

There are also other posts on warrants here on ASF, I've discussed it from time to time as I was confused about some issues myself. Worth a search but you'll have to trawl through some rubbish to get to the good stuff.

Let us know how you go.

PS Remember to see if warrants are the best way to go for every trade; an ETO or straight stock trade may be better.

 

[markrmau]

Re: Warrants v Options v other instruments

Just a few more points -

1. The market is only made when the stock is open and trading. Cannot participate in open/close.

2. Be wary of barrier/touch warrants. Make sure you undestand them before you use them.

3. Installment warrants can be so deep ITM that the only greek you need to worry about is the time decay - basically the interest rate on the borrowed amount. Again, the MM screws you by not dropping the value by .5c even if possible.

 

[GreatPig]

Re: Warrants v Options v other instruments

Thanks for the info folks. Funny about this thread though. I did a search on warrants before I posted the first message and didn't see this thread anywhere. Maybe I'm going blind in my old age.

Wayne, when you say you can't short warrants, do you mean in the way that you can write options?

Daryl Guppy has talked about put warrant trades in his newsletter a number of times, so I'll have to go back through those and find them. In a recent newsletter he compared put warrants to CFDs and reckoned the warrants were better for simple down-move trades. Can't remember why offhand though.

Cheers,
GP

 

[cuttlefish]

Re: Warrants v Options v other instruments

Wayne, when you say you can't short warrants, do you mean in the way that you can write options?

pretty sure that is what is meant by that from the discussions that I've read in the other threads. So you can go long on a stock by shorting some puts - no wonder a newbie like me has to read each post twice .

 

[sails]

Re: Warrants v Options v other instruments

Hi GP,

I'm no expert on warrants but have purchased instalments on occasions and have also been observing barrier warrants for a few months now. So here are the observations I have made so far:

Barriers trade with a delta very close to 1 (meaning they move almost cent for cent with the underlying share price) and I think I heard somewhere that they were initially introduced as competition to CFD's. The downside is that there is some extra (extrinsic) premium built into them so pays to get out (or roll to another strike) well before the strike price is hit. As an example, I watched a BHP $26 Barrier Call on Friday (BHP dipped to $25.94 before shooting back up) and the warrant still had about 20c of premium to it. Once it hit the $26 - it's all over for that warrant from that point and the issuers keep any remaining premium.

I found it helpful to first understand the components of option pricing as much of that is also applicable for warrant pricing. Wayne is correct is stating that you can't short (or write) warrants - meaning you can't sell them to open a position as you can with options. For this reason warrants tend to have fatter premiums than their option counterparts - and only the issuer's get the benefit from that excess premium! On occasions, I have looked to see if there is any benefit in buying a normal warrant instead of the same strike/month option, but the option has always come out infront by a considerable amount.

When purchasing instalment warrants, the first thing is to find out how much "extrinsic" value you are paying for. The first link below explains how to sort out intrinsic/extrinsic pricing under their "Warrant Info" - "Education" tab. Instalments are different to other warrants in that they pay dividends and franking credits are applicable.

In the case of instalment pricing, I keep it simple and consider that the pricing is made up of intrinsic value + the cost of a put option (same strike/month) and then the balance is pretty much interest. Anything over and above normal interest rates is generally volatility being priced into that warrant and usually safer to leave it alone if it's too high.

In most cases, deep in-the-money instalment warrants (meaning a strike price well below the share price) has very little volatility component and puts are cheap being so far away, so pricing is more likely to consist of just intrinsic value + interest. Also, puts have the dividend factored into them prior to x-dividend day- so don't be surprised by quite high put prices with strikes close to the share price.

Couple of sites: Oz Warrants including some education - http://www.ozwarrants.com.au/default.asp and also an online warrant calculator from Hoadley: http://www.hoadley.net/options/optiongraphs.aspx?warrant=Y I don't know of any good books on warrants, but Guy Bowers book on option trading as a good primer into basic options theory. Initially paper these type of derivatives is a good way to get a feel for them and helps to put the theory into perspective.

Hope this hasn't made it too complicated! Not real easy trying to summarise it into a post when a whole book could be written on the subject - but hopefully gives you a bit of an idea.

Cheers,
Margaret.

 

[wayneL]

Re: Warrants v Options v other instruments

Wayne, when you say you can't short warrants, do you mean in the way that you can write options?

Yes exactly

 

[RichKid]

Re: Warrants v Options v other instruments

Thanks for the info folks. Funny about this thread though. I did a search on warrants before I posted the first message and didn't see this thread anywhere. Maybe I'm going blind in my old age.

Wayne, when you say you can't short warrants, do you mean in the way that you can write options?

Daryl Guppy has talked about put warrant trades in his newsletter a number of times, so I'll have to go back through those and find them. In a recent newsletter he compared put warrants to CFDs and reckoned the warrants were better for simple down-move trades. Can't remember why offhand though.

Cheers,
GP

GP,

You can 'write' warrants via one of the instalment warrant issuers in the sense that you lend them your shares and they issue you instalment warrants, when you exercise your warrants you get your shares back and the divs can be used to reduce the oustanding payment to reclaim your shares- there are variable costs though so shop around (might be cheaper to just take out an investment loan and hold onto your shares (or write options)). But it's not quite as flexible as writing options, as Wayne mentions. You will find the terms in the instalment warrant pds's. Only available on some stocks. If I've confused you it's probably because I've forgotten what I've read in the pds- but basically you can convert your shareholding into warrants via a mm.

So if you want to free up some money from you share holdings you could lend the shares to the bank and they'll pay you part of the value of your shares- no CGT event as there has been no CGT event. I haven't checked the details of this so it requires further research. I was surprised to discover this as I was considering freeing up some $$$$'s from some long term holdings.

Might help to think of ASX listed warrants as a substitute for 'spread betting' sometimes, rather than as a variant of an option- that's how bad the mm's and liquidity can be (in spread betting the costs are often incorporated in the spread and you look to profit from a short term move in the sp).

 

[Magdoran]

Re: Warrants v Options v other instruments

Hello All.

I am PS 146 certified in derivatives and securities, but what I’m about to relate is based on my own personal experiences, and not on what is optimal for anyone reading this post.

Firstly, I want to make it clear that I’m not giving financial advice, and suggest individuals may consider seeking professional advice.

The best primary source of information for newer players is to go through the online ASX courses which are free, and very good for gaining an initial understanding of these instruments.

I also suggest that newer players think seriously about paper trading for around 12 months (or at least trade very small positions initially), or seek professional expert advice on derivatives, or all of these. The Guy Bower book previously mentioned is also well worth reading for new to intermediate players.

Let’s clear up a few technical points about Options Vs Warrants in the Australian context:

• Options are exchange traded instruments which are traded on exchanges and are regulated by the ASX/SFE and are government backed.

• Warrants are OTC (over the counter) instruments which are issued by a financial institution (e.g. Macquarie bank, etc), and are not standardised - the conditions are quite variable and are set by the issuer. Also, there is a potential credit risk if the issuer becomes insolvent or is impaired in some way to honour the Warrant.

• Exchange Traded Options (different form company issued options or other hybrids like converting notes for instance) often have market maker requirements (except for “flex options which do not have market maker requirements) which require a market to be made in a specified way, limits the width of the spread, and has other obligations.

• Warrants conditions on the other hand are stipulated in the issuer’s conditions (read these very carefully). Usually the bid and ask for instance is set by the issuer for warrants except where there are investors/traders active in the market.

There are a range of different types of warrants:

Investment warrants:
• Instalment
• Endowment

Call investment warrants usually allow you to earn the dividend while holding the warrants (hence they can be dearer, but work well in bull markets when looking to leverage long term positions, and reap the dividend. Also, the interest component may be eligible to be offset against taxation in some cases – please seek appropriate financial advice here).

Trading Warrants:
• Equity
• Index
• Currency
• Commodity
• Barrier/Knock-out

Most of these are self explanatory; see the above description about barrier or knock-out warrants.

Because warrants usually contain an interest component, they are often dearer than their option counterparts. The trade off is that some of these have set deltas, or yield dividends. The investment warrants are well suited to long term investing, and can yield both growth and income.

Warrants can differ slightly to options in that expiry for an option is final, where a reset or rollover component in some warrants allows for a continuation of leveraging – refer to the issuer for details.

Like options, the “Greeks” (see the thread on “Greeks” and options mentoring for more information) also affect key attributes for warrants such as time decay (theta), and delta (how quickly the warrant moves compared with the underlying).

Currently you can’t write a warrant – you have to actually own a warrant to sell it in the market. With options, you can sell or buy any eligible strike available if someone takes the opposite side of the transaction.

It is possible to use both warrants and options (and futures and CFD’s for that matter) in a comprehensive strategy.

To trade these leveraged instruments effectively you really need to understand a range of concepts such as calls, puts, the “Greeks”, and understand the nuances of the market you are trading in.

Warrant issuers for instance can invoke conditions you may not have been anticipating when dividends are issues, or when stock splits occur, or when special dividends or rights issues are involved. These also effect ETO’s (Exchange Traded Options), but the treatment of these situations is standardised, where with warrants they may not be.

So, the suitability of each instrument is quite involved. Options can allow a broad range of strategies, which warrants can’t, but some warrants can yield dividends, and others have set delta levels which simplifies calculating “greeks”. It is really up to the individual to do the due diligence, and determine the best risk to reward strategy for their situation.

Key things to consider are:
• Time frame - how long are you going to be in the trade? (intra day, a few days, mid term, long term).
• Level of risk.
• Investment approach – income, growth, speculation.
• Position size
• Hedging approach (if required).
• Personal knowledge and preferences

Like Margaret said, there are books on this sort of thing. I’ve traded both ETO’s and Warrants extensively, so this is just the tip of the iceberg believe me!

Hope this helps

Regards


Magdoran

 

[GreatPig]

Re: Warrants v Options v other instruments

Thanks again folks.

Just been plodding my way through the ASX material on warrants, and going through the Guppy newsletters to find the ones that have warrant trades.

Also been trying to read a book on options I've had for about 20 years: "Options Markets" by Cox and Rubinstein (two of the guys that developed the binomial pricing model I believe). It's rather heavy on the maths and quite a slog.

And I just ordered a couple of other books I've seen recommended: Sheldon Natenburg's "Option Volatility & Pricing", and David Caplan's "The New Option Secret - Volatility".

Plenty to keep me going for a while.

Cheers,
GP

 

[wayneL]

Re: Warrants v Options v other instruments

Thanks again folks.

Just been plodding my way through the ASX material on warrants, and going through the Guppy newsletters to find the ones that have warrant trades.

Also been trying to read a book on options I've had for about 20 years: "Options Markets" by Cox and Rubinstein (two of the guys that developed the binomial pricing model I believe). It's rather heavy on the maths and quite a slog.

And I just ordered a couple of other books I've seen recommended: Sheldon Natenburg's "Option Volatility & Pricing", and David Caplan's "The New Option Secret - Volatility".

Plenty to keep me going for a while.

Cheers,
GP

Lots of fun to be had there for you GP.

It will be nice to have more option traders on this board