Warrant poser, cash settlement calculation unfair say some

Monday April 30, 2012

By TEE LIN SAY 

linsay@thestar.com.my

PETALING JAYA: The calculation of cash settlement for call warrants has come under the spotlight as some investors argue that the current method is unfair.

They argue that the calculation of cash settlement for call warrants should not be determined based on the average closing price of the last five days, but instead be based on the volume weighted average price of the last five days.

Currently under Bursa Malaysia's listing requirements, issuers of structured warrants are able to determine for themselves the calculation of cash settlement based on three options:

(i) The volume weighted average price; or

(ii) The average closing price; or

(iii) The closing price of the underlying share or exchange-traded fund on the market day immediately before the exercise or expiry date.

However, most issuers presently use the average closing price as the method to determine cash settlement. Some dealers feel that this may be unfair because if the closing price of the mother share gets depressed on the last five days, then the cash settlement figure drops. “This has happened in a few instances, so it raises the question of whether a more dynamic price determination ought to be considered,” said one dealer.

He cited examples of Malaysia Building Society Bhd's (MBSB) call warrants which expired on April 18 and the DRB-Hicom-CH which expired on April 26.

“For the last five days where the price of the mother share was being used to determine the cash settlement, the price of MBSB's mother share was depressed at the close of four out of the five days,” said the dealer.

MBSB-CA expired at 5pm on April 18. Looking at the intraday charts of MBSB on April 11, 12, 13, 16, and 17, the share prices closed at the low of its day for April 11, 12, 16 and 17. The share prices started dropping towards 4.30pm.

For example on April 17, MBSB opened at RM2.19 and reached an intraday high of RM2.25. By 4.30pm, however, the share price had started dropping and it eventually closed (at 5pm) at RM2.17.

Basically, the higher the mother share, the higher the cash settlement for the warrant holder.

The exercise ratio was 3 MBSB-CA for every one MBSB mother share at an exercise price of RM1.48.

MBSB's closing price of RM2.18 was the average of the closing prices for the shares on each of the five market days immediately before the expiry date.

In the case of DRB-Hicom-CH, it expired on April 26. On the last five days of its closing before expiry, which were April 20, 23, 24, 25 and 26, its share price also dipped lower from the RM2.60-RM2.68 range it was trading in the last three weeks. For those five settlement days, the stock closed at an average price of RM2.45.

While it only closed at its intra-day low on April 23, it did close near to its day's low for the other four days.

A Bursa official said that Bursa's current rules were in line with those of other exchanges such as Singapore Stock Exchange (SGX) and the Hong Kong Stock Exchange (HKEX).

“However, in the discharge of our obligation to ensure a fair and orderly market, Bursa Malaysia has and will continue to review the effectiveness of its rules to ensure they meet their intended objectives,” said the Bursa official.

He added that SGX and HKEX allowed for options (ii) and (iii) .

http://biz.thestar.com.my/news/story.asp?file=/2012/4/30/business/11174530&sec=business

Warrants trading: What you need to know

Structured Warrants – Gearing & Greeks

In this article we will look at gearing factor and sensitivity coefficients – the Greeks which measure change in warrant value via change in other variables. 

Gearing & Effective Gearing: Structured warrants cost only a fraction of their underlying shares. They provide holders with greater exposure to price movements as they generally rise and fall more steeply in percentage terms. If a warrant is priced at RM0.30, and the underlying share is trading at RM1.50, the gearing is 5 times. The price of one warrant offers exposure to 5 shares. In bull markets, warrants will always be among the top risers and the opposite holds true in bear markets.

The definition of gearing is: 
Gearing = Share Price / Warrant Price (adjusted by exercise ratio) 

The following chart plots the relative price movements of a call and put warrant against corresponding movements in the underlying share price. Note the percentage change in the value of the underlying share compared with the value change in the call warrant and the put warrant. During a 3-month period, the underlying share price falls by 10% (at Point A) and increases by 8% (at Point B) - share price varies over an 18% range. In contrast, the call warrant fluctuates within a 75% range, while the put warrant fluctuates within an 80% range but in an opposite direction to the call. 
Gearing decreases as the share price increases. 

Delta & Gamma: Delta refers to the rate of change of warrant price for a given change in the underlying share price. For call warrants, the delta will fall between 0 and 1; for puts it will be between 0 and -1. At 0, the warrant is impartial to any moves on the underlying share. At 1, the warrant is expected to move sen-for-sen with the underlying share. Typically, at-the-money warrants will have a delta of 0.5. As the warrant moves in-the-money, the delta will approach 1. 

The most savvy of traders will aim for medium-delta warrants, in the range of 0.4 to 0.5. Any delta too low will denote an out-of-money warrant with strike too far away. 

The delta is a constantly changing number. The rate of change of delta is known as the gamma. One could visualise delta as the speed of the warrant, and gamma as the acceleration. The gamma simulates the changes on the warrant price for different underlying share price. Any move on the underlying share will move the delta higher, as with the gamma. 

Vega: Vega measures the sensitivity of warrant price to change in volatility. Vega is the highest for at-the-money warrants, and tends to be higher for longer-dated warrants. 

With several issuers issuing warrants on the same shares, the belief is that investors and traders should focus on the warrant with the lowest implied volatility. This is only true if the issuers will buy back their warrants at a proportionate volatility level. An example would be buying a warrant at an implied volatility of 45%, which the issuer buys back at 42% versus buying a warrant at a volatility of 40% that is bought back at a volatility of 30%. 

Theta: Also known as time decay, Theta is expressed in terms of sen or percentage per week (or per day closer to expiry). Eventually, the warrant will need to lose the time value entirely. But theta is not linear to time – it will get proportionately larger as it approaches expiry. 

Rho: Rho measures the sensitivity of warrant prices to changes in interest rates. However, the level of interest rates, as a variable, is likely to influence neither warrant pricing nor trading decision making process. 

Final Thoughts: The Greeks do not help answer which warrant to buy. However, they are reliable forecasting tools on the changes in warrant prices versus the underlying share price movements. 


Related:

Warrants trading: What you need to know  Parameters & Variables of Structured Warrants

http://bursaedge.blogspot.com/2012/02/warrants-education-2.html