Pluck value from something without actually owning it? Say hello to warrants.
What is a warrant? Derivatives, warrant types and trading
Warrants are financial products dished out by investment banks, governments and other financial institutions - and traded on the Australian Stock Exchange.
Being derivatives, they literally derive their value from and give investors exposure to an underlying asset - that being a share, basket of shares, index, currency or commodity. This is all at a fraction of the underlying asset's cost.
There are different types of warrants available. Some are suited to short-term trading and others to longer-term investment.
Trading warrants are higher risk/higher return, while longer-dated warrants, such as installments, are traded less frequently and have a lower risk/lower return.
Warrants, such as index types, entitle you to a cash payment relevant to the value of the underlying asset at a particular time. Others give you the right to buy or to sell the underlying asset to the warrant issuer at a price determined by its terms.
Overall, the shorter-term trading-style warrants include knock-out and trading warrants, while longer-term investment-style types include installment, endowment, structured investment and non-leveraged gold versions.
Investing with warrants: achieve leveraged exposure and minimise risk
There are a few reasons. You can:
- Achieve a leveraged exposure to an underlying share, such as Commonwealth Bank
- Diversify your exposure to the share market or a particular market sector
- Generate an income through dividends and franking credits, and
- Protect the value of your share portfolio.
With warrants, small percentage changes in the value of the underlying assets result in larger percentage changes in the warrant's value - hence, gaining exposure while not forking out to buy the assets outright.
Warrants also entitle you to the full dividends and franking credits paid on the underlying assets - without actually owning them. Transaction costs are also lower.
Frequently asked questions: warrant expiry, brokers and reading warrant codes
Here are some answers to a few frequently asked questions:
How do I read a warrant code in my local rag?
Each warrant has a six-letter code. The first three letters are the Australian Securities Exchange code for the underlying asset, the fourth displays the warrant type, the fifth, the warrant issuer, and the sixth, the warrant series.
What happens if I forget to exercise my warrant before it expires?
You may be entitled under certain circumstances to a cash payment if you have deliverable warrants, but do not exercise them before expiry. If your warrant has no real value, it will expire worthless.
How can I reduce the brokerage costs when trading warrants?
Generally, full-service brokers charge more than discount or online brokers. In addition, some warrants - typically, installments and capital-protected types - can be bought off-market directly from the issuer with little or no fees. However, selling warrants requires a broker. Further, some warrants can expose you to a group of shares within a sector, which can mean you only have to pay one brokerage, instead of, say, five.
