This is the last post of the Actual Operation of Warrant Trading. In our last post, we will talk about the last trading day, expiry date and payout date.
If an investor waits until the maturity to ask the broker to sell his warrant holdings on hand, the instruction may be rejected. It is because that the last trading day has passed!
If it is only at the last minute that you find out the last trading day is before the expiry date, you might have lost the last chance for selling. Under the requirements of the Singapore stock exchange, the last trading day of a warrant must be the fourth trading day (excluding any Saturday, Sunday or public holiday) before its expiry date. In fact, investors may work that out for themselves with reference to the expiry date disclosed by the issuer.
Let us look at the example of SPCSGAECW081013. From the code, the expiry date is on the 13th October 2008 and the last day of trading will be on 7th October 2008 that is fourth trading day before expiry. Based on these terms, the trading came to an end after 7th October 2008.
When a warrant has expired, the issuer will transfer the settlement amount to the securities settlement account of the investor through the Central Depository (CDP). Generally, the payout date is around three working days afterwards when the money is transferred to the CDP (depending on the specific arrangements of the issuer concerned). The money will then be redirected to the investor by his or her broker or bank.
There will always be 5 valuation dates. In other words, the closing price of a valuation date may be used twice should there be a Market Disruption Event (MDE) on the previous valuation date. The Macquarie Warrant Hotshot competition begins today at 0900H, all the best for those who have sign up for the game.
Monday 14 July 2008
Sunday 13 July 2008
Actual Operation of Warrant Trading (Part 5)
With the Macquarie Warrant Hotshot Competition starting tomorrow, it is time for me to post the last two posts on Actual Operation of Warrant Trading. In this post, we will focus on the calculation of settlement price.
The method of calculation of settlement price differs for stock warrants, index warrants and other types of warrants. In general, it is not as complicated as one might think. We will discuss only the calculation method for standard warrants. We will not be touching on the settlement for exotic warrants.
Stock Warrant
The settlement level of a stock warrant is the average closing price of its underlying for the five trading days immediately preceding the expiry date. This is true across most of the warrant issuers that I have studied. Take for example, the call warrant OCBCSGAECW080707 which is issued by Société Générale (SGA) on the underlying OCBC counter which expires on 7th July 2008 with a strike of S$8.00. The conversion ratio on this warrant is 1:3 which means we need three warrants to convert into a single OCBC stock.
The settlement calculation is computed as follow,
For call: Max { [(Settlement Price – Strike Price) ÷ Conversion Ratio ] ÷ Exchange Rate., 0 }
For put: Max { [(Strike Price - Settlement Price) ÷ Conversion Ratio ] ÷ Exchange Rate., 0 }
From the screen capture above, the last five trading days prior the expiry date of the call warrant on 7th July 2008 are 30th June, 1st July, 2nd July, 3rd July and 4th July. Notice 5th and 6th July are weekends and are not consider part of trading days. The settlement price is calculated as follow, based on the closing price at the end of each trading day.
The method of calculation of settlement price differs for stock warrants, index warrants and other types of warrants. In general, it is not as complicated as one might think. We will discuss only the calculation method for standard warrants. We will not be touching on the settlement for exotic warrants.
Stock Warrant
The settlement level of a stock warrant is the average closing price of its underlying for the five trading days immediately preceding the expiry date. This is true across most of the warrant issuers that I have studied. Take for example, the call warrant OCBCSGAECW080707 which is issued by Société Générale (SGA) on the underlying OCBC counter which expires on 7th July 2008 with a strike of S$8.00. The conversion ratio on this warrant is 1:3 which means we need three warrants to convert into a single OCBC stock.
The settlement calculation is computed as follow,
For call: Max { [(Settlement Price – Strike Price) ÷ Conversion Ratio ] ÷ Exchange Rate., 0 }
For put: Max { [(Strike Price - Settlement Price) ÷ Conversion Ratio ] ÷ Exchange Rate., 0 }
Based on the above formula, we need to know how to compute the settlement price so we can do the computation for the settlement at expiry.
From the screen capture above, the last five trading days prior the expiry date of the call warrant on 7th July 2008 are 30th June, 1st July, 2nd July, 3rd July and 4th July. Notice 5th and 6th July are weekends and are not consider part of trading days. The settlement price is calculated as follow, based on the closing price at the end of each trading day.(S$8.17 + S$8.07 + S$8.15 + S$8.08 + S$8.05) ÷ 5 = S$8.104
This is above the strike of S$8.00 which is ITM and hence the settlement calculation is
Max { [(S$8.104 - S$8.00) ÷ 3] ÷ S$1.00, 0 } = S$0.034667 per warrant.
Hence if you have bought 10 lots of OCBCSGAECW080707, you will have receive a payment of S$0.034667 X 10 X 1000 = S$346.67.
Let’s take a look at the call warrant SPCSGAECW080707 on the underlying SPC counter which expires on 7th July 2008 too with a strike of S$7.88. The conversion ratio on this warrant is 1:5 which means we need five warrants to convert into a single SPC stock.
The screen capture above showed the last five trading days prior the expiry date of the call warrant. Again, the settlement price is calculated as follow, based on the closing price at the end of each trading day.
(S$6.60 + S$6.72 + S$6.83 + S$6.95 + S$6.91) ÷ 5 = S$6.802
Notice this is below the strike of S$7.88 which is OTM and hence the settlement calculation is
Max { [(S$6.802 - S$7.88) ÷ 5] ÷ S$1.00, 0 } = S$0.00 per warrant.
Hence if you bought 10 lots of SPCSGAECW080707, you will not receive anything in return.
Option trader might find the settlement of warrant is quite different from that of the option. The different being the settlement price is taken from the average of the last five trading days of the underlying rather than the last closing price of the underlying one day prior to the expiry of option.
The rationale behind such approach is to prevent anyone who has enough capital to move the stock price of the counter through market manipulation such that the warrant will become ITM at expiry. Take for example in the case of the SPC call warrant above. Suppose the strike of this warrant is S$7.00 instead of S$7.88 and if the settlement calculation is computed based on the last closing price on the trading day prior to the expiry of the warrant. If a person or an institutional investor has enough capital to buy into the SPC stock at near the closing bell of the day to push up the price of the SPC counter to be above S$7.00, say S$7.10, then for each warrant the investor holds, he or she will receive S$0.02 per warrant at settlement.
Of course this is a hypothetical situation but it is not possible in real life. Having the average of the last five trading days’ closing price as settlement price is to prevent such market manipulation from happening cause it is more difficult to move the stock price for five consecutive days than in a single time frame at closing bell. However, if the investor does have the capability to move the stock price for five consecutive days, the Singapore Exchange may already halt the trading of the underlying before further manipulation happens.
Index Warrant
The settlement level of an index warrant differs across different issuers. I have listed the method of settlement for the Straits Time Index (STI) for various issuers below based on my findings.
- For Société Générale (SGA), the settlement for the STI is based on the final settlement of the future contract of the STI. The future contract settlement for STI can be found here.
- For Deutsche Bank (DB), the settlement for the STI is based an amount equal to the reference level on the valuation date or an amount equal to the arithmetic average of the reference levels on all the valuation dates, as determined by the issuer and without regard to any subsequently published correction.
- For BNP Paribas (BNP), the settlement for the STI is based on the five days average closing price of STI.
- For Macquarie Capital Securities (MBL), there is no warrant issued for STI that I can find.
- For Rabo Bank (RB), I cannot find any settlement details on how they compute for both equities and index.
The formulae used to compute the settlement calculation for index is the same as the ones used to calculate for stock. For example, the settlement for put warrant STI3200SGAEPW080627 on the underlying STI which expires on 27th June 2008 with a strike of 3200 and conversion ratio of 500 is as follow,
Max { [(3200 – 2947.8) ÷ 500] ÷ S$1.00, 0 } = S$0.504400 per warrant.
The settlement level 2947.8 is gotten from the Singapore exchange website. See the screen capture below.
Please do take note that the settlement for HSI index listed in Singapore exchange by various issuers may have a different settlement procedure compared with STI. I have listed the links below where you can find the calculation of the settlement for all the expired warrants by different issuers.
- For Société Générale (SGA), the settlement details can be found here.
- For Deutsche Bank (DB), the settlement details can be found here.
- For BNP Paribas (BNP), the settlement details can be found here.
- For Macquarie Capital Securities (MBL), the settlement details can be found here.
- For Rabo Bank (RB), I cannot find any settlement details on how they compute for both equities and index.
I hope this post has given my readers an idea on the settlement for both Singapore equities and Index. The same formula can be used to compute for plain vanilla warrants issued on equities or index in Hong Kong or Japan. We just need to pluck in the exchange rate in this case and also find out on how the settlement level is determined.
Thursday 3 July 2008
Exploring the Precursor to Straight Through
I miss out the portion on Straight Through Processing (STP) earlier on and take the opportunity now to post it here, thanks to Shashank Mahajan who reminder me. I seriously didn’t expect someone from New York to be reading my blog. Thanks for your support.
To understand STP, you need to understand the concepts of the front office, middle office, and back office. These are, role-wise, the segregation in a member’s office or trading institution’s office.
The front office is responsible for trading. In a broker’s office, the front office speaks to various customers and solicits business. The front-office staff is also responsible for managing orders and executing them.
The back-office staff is responsible for settling transactions. The back office ensures that all obligations toward the clearing corporation are met seamlessly and that the member receives its share during pay-out.
While this entire process is happening, the middle office monitors all limits and exposures, and thus risks that the firm is assuming. The middle office is also responsible for reporting, especially where corporate-level reporting is required.
Since a broker’s office is organized into front, middle, and back offices, solution providers structure their products in the same fashion in the form of modules. Although many vendors provide solutions for all three sections, it is not mandatory for a broker to buy all three modules from the same vendor. If a broker goes for different vendors, though, then they have an issue of inter-module communication. Most brokers want all the three modules to be integrated. If they are not, then data will have to be entered multiple times in these modules. To obviate from this problem, brokers rely on a concept called STP.
STP, as defined by the Securities Industry Association (SIA), is “...the process of seamlessly passing financial information to all parties involved in the transaction process, spanning the investment manager decision through to reconciliation and statement production, without manual handling or redundant processing in real time.”
Two types of STP exist: internal and external. In the case just discussed, internal STP is required because you need to connect modules installed in a broker’s office. But some other entities such as custodians, fund managers, and so on, play an equally important role in settlement. To achieve true STP, even these need to be connected to each other. Any attempt to connect such entities beyond the organization in pursuit of STP is called external STP.
The industry wants to put processes in place that will allow an order to flow right from deal entry to conversion to trade to affirmation and confirmation and finally through settlement and accounting without manual intervention. This is because the industry wants to move toward T+1 settlement. This means trades done on one day will get settled the next day. This is an ambitious plan because it will call for a lot of process change, technology change, and industry change. Applications will have to come together and orchestrate the entire business process.
STP provides a lot of benefits to industry participants:
To understand STP, you need to understand the concepts of the front office, middle office, and back office. These are, role-wise, the segregation in a member’s office or trading institution’s office.
The front office is responsible for trading. In a broker’s office, the front office speaks to various customers and solicits business. The front-office staff is also responsible for managing orders and executing them.
The back-office staff is responsible for settling transactions. The back office ensures that all obligations toward the clearing corporation are met seamlessly and that the member receives its share during pay-out.
While this entire process is happening, the middle office monitors all limits and exposures, and thus risks that the firm is assuming. The middle office is also responsible for reporting, especially where corporate-level reporting is required.
Since a broker’s office is organized into front, middle, and back offices, solution providers structure their products in the same fashion in the form of modules. Although many vendors provide solutions for all three sections, it is not mandatory for a broker to buy all three modules from the same vendor. If a broker goes for different vendors, though, then they have an issue of inter-module communication. Most brokers want all the three modules to be integrated. If they are not, then data will have to be entered multiple times in these modules. To obviate from this problem, brokers rely on a concept called STP.
STP, as defined by the Securities Industry Association (SIA), is “...the process of seamlessly passing financial information to all parties involved in the transaction process, spanning the investment manager decision through to reconciliation and statement production, without manual handling or redundant processing in real time.”
Two types of STP exist: internal and external. In the case just discussed, internal STP is required because you need to connect modules installed in a broker’s office. But some other entities such as custodians, fund managers, and so on, play an equally important role in settlement. To achieve true STP, even these need to be connected to each other. Any attempt to connect such entities beyond the organization in pursuit of STP is called external STP.
The industry wants to put processes in place that will allow an order to flow right from deal entry to conversion to trade to affirmation and confirmation and finally through settlement and accounting without manual intervention. This is because the industry wants to move toward T+1 settlement. This means trades done on one day will get settled the next day. This is an ambitious plan because it will call for a lot of process change, technology change, and industry change. Applications will have to come together and orchestrate the entire business process.
STP provides a lot of benefits to industry participants:
- STP reduces settlement time. This essentially reduces risk because transactions will be settled faster and will be irrevocable. Settlements are said to be irrevocable when they are considered to be final and cannot be reversed. Reduced settlement time also means better utilization of capital.
- Less manual intervention will mean fewer operational risks and errors. It will also mean fewer costs.
- STP will force the entire industry to move toward standard communication protocols. This will mean standardized systems and fewer system development and maintenance costs. Interoperability will be a prerequisite for this to happen.
- Increased automation will lead to increased throughput in transaction processing, thereby enabling institutions to achieve greater transaction volumes.
Equity trading and STP by itself are vast subjects, and understanding every minute business detail in a single go is not possible; furthermore, the functioning of every stock exchange is different from one another (though the concepts are fairly standard).
Monday 30 June 2008
Macquarie Warrant Hotshot Competition
For those who have been trading options, you will realize that there are a lot of virtual trading platforms out there for you to practice your strategies and polish up your skills. Unfortunately, this is not so true for warrant trader. I do my own virtual trade on a spreadsheet I created but then it lacks the real time data feed.
Macquarie is organizing the second Warrant Hotshot competition which is a real-time simulated trading contest designed to improve your knowledge of warrant investing without risking any capital. In fact, you could stand to win the S$20,000 Grand Prize if you are crowned Singapore's Warrant Hotshot.
The Hotshot contest is suitable for investors of all skill levels from newcomers to experienced warrant traders. Participants will begin the contest with S$100K Hotshot dollars and prizes will be awarded to those who are able to generate the largest profits by trading Macquarie warrants in the simulated trading environment. Warrant prices in the contest will mirror the real warrant prices on the SGX.The competition will be segmented into four main categories: dealers, investors, media and students, with participants from each category competing against each other for the weekly and group prizes. There will also be a grand prize winner for the investor with the largest portfolio at the end of the competition.The contest is scheduled to start on 14 July 2008 and will run for a period of 8 weeks. Please click here to register.
You can register under the appropriate category. For convenient sake, I have re-posted the Rules and Regulations here for your reference.
Introduction
Macquarie is pleased to present the second Macquarie Warrant Hotshot contest to investors. The contest is designed to give new and existing warrant investors the opportunity to experience trading warrants in a real-time simulated environment. Live pricing for both warrants and their respective underlying will mirror those seen on the SGX main board.
Eligibility
Macquarie is organizing the second Warrant Hotshot competition which is a real-time simulated trading contest designed to improve your knowledge of warrant investing without risking any capital. In fact, you could stand to win the S$20,000 Grand Prize if you are crowned Singapore's Warrant Hotshot.
The Hotshot contest is suitable for investors of all skill levels from newcomers to experienced warrant traders. Participants will begin the contest with S$100K Hotshot dollars and prizes will be awarded to those who are able to generate the largest profits by trading Macquarie warrants in the simulated trading environment. Warrant prices in the contest will mirror the real warrant prices on the SGX.The competition will be segmented into four main categories: dealers, investors, media and students, with participants from each category competing against each other for the weekly and group prizes. There will also be a grand prize winner for the investor with the largest portfolio at the end of the competition.The contest is scheduled to start on 14 July 2008 and will run for a period of 8 weeks. Please click here to register.
You can register under the appropriate category. For convenient sake, I have re-posted the Rules and Regulations here for your reference.
Introduction
Macquarie is pleased to present the second Macquarie Warrant Hotshot contest to investors. The contest is designed to give new and existing warrant investors the opportunity to experience trading warrants in a real-time simulated environment. Live pricing for both warrants and their respective underlying will mirror those seen on the SGX main board.
Eligibility
- Participants must be aged 21 years or above at the time of registration.
- All staff and their immediate family members of Macquarie Capital Securities (Singapore) Pte. Limited (Registration Number 198702912C) and Macquarie Capital (Singapore) Pte. Limited (Registration Number: 199704430K) and their related body corporate are not eligible to receive any prizes in this Macquarie Warrant Hotshot contest.
- Participants can be of any nationality.
- Participants must be residing in Singapore.
- To be eligible for any prize, the following conditions must be met:
- The Participant must have complied with the rules and regulations stated.
- The Participant must have completed at least one (1) buy trade (using the virtual cash in the Hotshot Account) during the term of the contest.
- The Participant must not have been disqualified from the contest.
Registration
- Participants can sign up for only one Hotshot Account. Participants must register their own personal particulars, and not use another person's particulars to register for the contest. Participants must not trade using another participant's Hotshot Account.
- Participants must register using their names as stated in their NRIC or Passports. NRIC or Passport numbers registered must be valid and accurate to be eligible to win a prize. Participants who fail to produce a valid form of identification will not be awarded cash prizes should they be declared winners for the respective prizes. Driver licenses will not be acceptable.
- Participants must register in their appropriate category i.e. Remisiers and Dealers, Private Investors, Media and Students. Any participant competing in the Remisiers and Dealers, Media or Student categories will be asked for proof of their employment within these industries (or proof of study for the student category) before any prizes are awarded. A letter from their respective companies and institutes of learning, along with their NRIC or passport may be required for verification. Participants working in any publishing, or broadcasting company qualify as Media participants. Participants who have doubts as to whether they qualify for a particular category may contact the warrants team at 1800 288 880. Any participant competing in the wrong category will not be eligible for any prizes.
- Participants must agree to be bound by the Rules & Regulations set by Macquarie Capital Securities (Singapore) Pte. Limited.
- Macquarie Capital Securities (Singapore) Pte. Limited reserves the right to change the Rules & Regulations of the contest, and will disqualify any participants breaching the rules stated herewith.
- Macquarie Capital Securities (Singapore) Pte. Limited also reserves the right to disqualify any participants attempting to tamper the trading system or influence the warrant prices by manipulating the underlying prices. Any breach of market misconduct will be reported to the SGX and / or the Monetary Authority of Singapore.
Participants can sign up for the contest anytime from 30 June 2008 9am by completing the registration form online at http://www.warrants.com.sg/. - In case of any dispute, Macquarie Capital Securities (Singapore) Pte. Limited will have the final discretion in the award of any prizes.
Contest & Prize Details
- The contest will last for 8 weeks, starting at 9:00 am on 14 July 2008 and ending at 4:59 pm on 5 September 2008.
- Each participant will start the contest with an initial credit of 100,000 points, with every one point being the hypothetical equivalent of one Singapore dollar.
- There is a "reset" option (My Portfolio -> Personal Portfolio), where players can start over with a credit of 100,000 points, and have their previous trades deleted. They will not be eligible for the Weekly Hotshot Prize for that particular week. However, they will still be eligible for the Grand Hotshot Prize as well as the Category Hotshot Prize.
- There will be 4 categories: 1) Remisiers and Dealers 2) Private investors 3) Media 4) Students. Participants can track the names of the top 5 Hotshots in each category on the contest website.
- There will be four winners for the Weekly Hotshot Prize each week. The weekly winners will be the participants in each of the four categories with the highest percentage gain in his or her portfolio that week. The percentage gain in the portfolio is measured from the close of market on Friday that week, and comparing it to the Friday before. E.g. For the week starting 21 July 2008 and ending 25 July 2008, the percentage gains for that week will be calculated as:
(P25 - P18)/ P18 x 100%
where P25 is the total credits of the portfolio at the close of 25 July 2008 and P18 is the total credits of the portfolio at the close of 18 July 2008.
- For warrants over Singapore stocks, the market value of a participant's holdings will be calculated based on the warrant bid price at 4:59 pm.
- For warrants over Hong Kong stocks, the market value of a participant's holdings will be calculated based on the warrant bid price at 3:59 pm. For warrants over Hang Seng Index ("HSI"), the market value of a participant's holdings will be calculated based on the warrant bid price at 4:28 pm.
- After 8 weeks, there will also be one Category Hotshot Prize winner in each category. This will be the participant with the largest portfolio value in terms of credits from each category, regardless of when the participant joined the contest.
- After 8 weeks, there will be one Grand Hotshot Prize. This will be the participant with the largest portfolio value in terms of credits, regardless of when the participant joined the contest. Do note that the winner of the Grand Hotshot Prize will also be the winner of his or her Category Hotshot Prize, and could potentially be the winner of the Weekly Prize for the last week. However, only the cash value of the Grand Hotshot Prize will be awarded.
- The cash value for each of the prizes is stated below:
- Grand Hotshot Prize: S$20,000 for the grand winner.
- Category Hotshot Prize: S$3,000 per winner (total 3 winners)
- Weekly Hotshot Prize: S$200 per winner each week (total 32 winners)
- Participants are allowed to win weekly prizes more than once.
- To be eligible for any prize, the following conditions must be met:
- The Participant must have complied with the Rules & Regulations stated herewith
- The Participant must have completed at least one buy trade (using the credits in the Hotshot Account) during the duration of the contest.
- The Participant must not have been disqualified from the contest.
- In the case of a tie, the prize will be split equally among the relevant participants. For example, in relation to the Grand Prize, a tie for Grand Prize between two Participants means that both will share the cash prize of $20,000 equally between themselves i.e. S$10,000 each.
- All winners will be notified by mail at their registered address in Singapore. Prizes must be collected within a month from notification.
- If a participant's portfolio ranks among the top weekly or overall portfolios in each category in terms of performance, their registered name in their NRIC or Passports and/or their portfolio/holdings may be displayed on the contest website or in the newspaper. All Participants who win a prize shall agree to allow their names and photographs to be used in public communication medium such as, but not limited to newspaper, internet or television.
Trading Details
- Orders placed to buy or sell Macquarie warrants can be executed at any time of the day during trading hours (9:00 am - 12:30 pm, 2:00 pm - 4:59 pm). Participants will not be able to execute orders during the pre-open matching period (8:30 am - 8:59 am) and the pre-close matching period (5:00 pm - 5:05 pm).
- For warrants over Hong Kong underlying stocks, these will trade according to the Hong Kong market trading hours: 10:00 am - 12:30pm, and 2:30pm - 3:59pm. Participants will not be able to execute orders during the pre-open and pre-close matching periods also.
- For warrants over the HSI, these will trade according to the Hong Kong Hang Seng Index Futures trading hours: 9:45 am - 12:30 pm, and 2:30 pm - 4:28 pm.
- Price quotes for Hong Kong stocks will not be displayed on the contest website. There will be a link to take participants to the relevant webpage on the Hong Kong Stock Exchange website, where prices are quoted with a 15 minutes delay. However, the price quotes for warrants over Hong Kong stocks will be live.
- Quotes for HSI will not be displayed on the contest website. There will be a link to take participants to the relevant webpage on the HSI website. The price quotes for warrants over the HSI will be live.
- All orders for the day will expire if they are not matched by the end of the trading day. However, orders placed after markets close will be saved in the system and matched at the first minute after the respective markets open.
- Should a participant execute a large order, such as buying 1 million warrants on the offer when there is only 200,000 on the screen, the contest trading platform will execute the order in multiples of 200,000 with a 2 second lag e.g. Buy 200,000 warrants, and the next 200,000 warrants will be bought only after a 2 second lag. This feature attempts to simulate the real world, where issuers will replenish the volume on the offer at the same price in the warrants should the underlying share price not move and there is sufficient volume in the underlying for issuers to hedge their positions.
- Orders executed in the contest will be done immediately to simulate real time trading. However, participants should note that if the bid / offer quote in the warrant is $0.20 / $0.205, and if participants wish to buy the warrant and get their order filled immediately, they should pay the offer and buy the warrant at $0.205. If they choose to bid at $0.20, their order will be filled only when the warrant ticks down to $0.195 / $0.20.
- Participants can cancel or reduce the quantity of their buy and sell order if such an order has not been filled, i.e. in the 'Pending Orders' section.
- To increase the quantity of an order, a new order entry has to be made.
- Once an order has been filled, the order cannot be cancelled or amended.
- No odd lots may be traded. The minimum volume is set at 1,000 warrants or 1 board lot.
- Short selling of warrants will not be allowed. Participants can only sell warrants which they own, as there will not be a buy-in market for participants with overnight net short positions for the duration of the contest.
- In the event that an underlying stock is placed on a trading halt, the corresponding warrants will be placed on a trading halt in the contest.
- If an order is placed for a warrant whose underlying is on a trading halt or suspension, the order will not be processed until the trading halt or suspension is lifted.
- If a Participant holds a warrant whose underlying is on a trading halt or suspension, the warrant cannot be sold until the trading halt or suspension has been lifted. If there is a trading halt or suspension on an underlying stock at the end of the contest, the last quoted bid / offer price in the warrant before the trading halt or suspension will be used for the final valuation of the warrant.
- If an underlying stock is delisted on the SGX market, the corresponding warrants will be delisted in the contest.
- If a company and its corresponding warrants are delisted, a Participant's warrants will hold no value and its value will be removed from the Participant's portfolio.
Payments & Sale Proceeds
- There are no brokerage commissions, clearing fees, GST and any other miscellaneous charges in the simulated trading environment of the contest. Participants' profits and losses will be based on the capital gains and losses from trading the warrants.
- There will be no margin financing option in the contest.
- There will be no contra period for any warrants purchased. The payable amount will be immediately deducted from the participants' 'Cash Balance'.
- When submitting a buy order, there will be a check for sufficient funds (credits) in the participant's Cash Balance. Once a buy order is completed, the required amount will be immediately deducted from the participant's Cash Balance. If the order is rejected because the participant does not have enough 'Cash Balance', the participant needs to adjust the quantity of warrants or the limit price.
- When the participant's sell order has been executed, the sales proceeds will be immediately credited into the participant's Cash Balance. Under Realized Profit/ Loss, the participant can monitor the amount of realized profits or loss, if any.
Adjustments to Warrant Terms
- Ordinary dividends are incorporated into the price of a warrant so that on the ex-dividend date when the share price falls by the amount of the forecast dividend, the warrant price should not change.
- Special dividends, capital reduction and or any other corporate measures undertaken by a company may affect the price of the warrants. Macquarie will issue an official announcement on the SGX, stating the details of the adjusted strike prices and entitlement amounts on both the SGX website and Macquarie's Warrants Homepage. The adjusted strike prices and entitlement amounts will be automatically updated in the contest.
Investment Warrants
- Investment Warrants are a new type of warrant that Macquarie introduced to Singapore early in 2008. Different from conventional 'trading' warrants currently traded on the SGX, which typically have a contract expiry of three to six months, Investment Warrants have lower exercise prices and longer expiry dates, therefore giving them lower holding costs and a lower risk profile than conventional trading warrants.
- Investment Warrants allow investors to receive net ordinary dividend equivalent payments. Thus if a company declares a 50 cent net ordinary dividend, the investor will receive the full 50 cent equivalent payment if you purchase the proportionate number of Investment Warrants to entitle you to 1 underlying share. For example if you were holding an investment warrant with a warrants per share number of 10:1 and the underlying share announced a dividend of 50 cents, each warrant that you hold would be entitled to 5 cents (i.e. 50 cents divided by 10)
- On the SGX these dividend payments are distributed to the holder within 5 days of the dividend payment date. In the contest they will be credited to the investors account on the day of the ex-dividend date as the contest will only last eight weeks while the dividend paid date may be longer than the duration of the contest.
- Special dividends, capital reduction and or any other corporate measures undertaken by a company may be adjusted in the same way as a conventional trading warrant (see section above)
All the best to those who are participating in the contest.
Saturday 21 June 2008
Actual Operation of Warrant Trading (Part 4)
In this post, I’ll discuss a rather simple topic on the “Actual Operation of Warrant Trading”. This post will focus on the continuous quote of warrant trading. In Singapore, market makers provide liquidity to the market under a continuous quote system.
There are however under some circumstances that market makers will not be able to provide any quotation. The following is a list of such situations.
There are however under some circumstances that market makers will not be able to provide any quotation. The following is a list of such situations.
- When the warrant is suspended from trading for any reason, including, without limitation, as a result of its underlying being suspended from trading;
- In the event of the occurrence of a market disruption event, including, without limitation, any suspension of or limitation imposed on trading (including but not limited to unforeseen circumstances such as by reason of movements in price exceeding limits permitted by the SGX-ST or any act of god, war, riot, public disorder, explosion, terrorism or otherwise ) in a stock, or any warrant, option contract or futures contract relating to the stock;
- When the issuer and/or the guarantor hold(s) less than 5% of the total issue size of the warrant (in which event, quotes will be for bid price only), that is, when the guarantor and its group of companies hold, in their proprietary position, less than 5% of the total issue size of the warrant, which, for the avoidance of doubt, shall exclude any unit of the warrant held by the guarantor and/or its groups of companies in a fiduciary or agency capacity;
- During the period of five business days immediately prior to the expiry date of the warrant;
- If the stock market experiences exceptional price movement and volatility, that is to say, during fast market; and
- Where the market maker faces technical problems affecting the ability of the market maker to provide bid and offer quotations.
The most commonly seen situation is case 4 when the warrant is not tradable any more. I hope this post will give a rough idea to investors to the different situations why there are times when warrants do not have any quotes. In the next “Actual Operation of Warrant Trading” posting, I’ll be discussing about the calculation of warrant settlement price for both equities and index.
Thursday 19 June 2008
How to compute the historical volatility of index and equities?
In this post, I’ll divert from the discussion of the “Actual Operation of Warrant Trading” and talk about how various issuers of warrant compute the historical volatility of index and equities. In fact, what I am going to illustrate later can also be applied to the US market to compute the historical volatility of index and equities.
From the above screen captures, we can see that the historical volatility is around 15.01%. We are not concern about the different terms of warrant chosen as long as they all have the same underlying; their historical volatility should be approximately the same.
Under the column with the heading showing “Percentage Change”, the value in each cell is computed based on the natural logarithm of the prior day closing index and today closing index. Take for example, the percentage change on 18th June 2008 is computed as follow, Ln(3040.09/3028.24) = 0.39%.
Once we have all the various percentage change calculated for the last 30 days, not including the one on 19th June 2008, since this is a historical volatility. To compute the historical volatility for last 30 days, we first find the standard deviation of the percentage change from 8th May 2008 to 18th June 2008 and then multiply it with the square root of 250 or 252; the number of trading days in a year. That is Stdev(-1.78%, -0.31%, 0.57% ….-0.29%, 0.39%)*Sqrt(250) = 15.02%. The reason why we multiply the standard deviation with the square root of the number of trading days is to annualize the historical volatility.
Based on the theory of statistic, if the sample is 30 and above, we can assume the distribution to be normal. This is why I have chosen 30 days and nothing less. Assuming if the STI index does follow the normal distribution, then there is a 68% of the time the STI index will fall within 2992.66 * (1 ± 15.02% * Sqrt (30/250)), which gives us a range of 2836.95 to 3148.37. We multiply the historical volatility with the Sqrt(30/250) to de-annualize it. For those who attended the last WAT gathering, do you find this formula familiar? What happen if we substitute the 2992.66 with half the current equity share price, the 15.02% with the ATM option implied volatility and the 30 with the days to expiration of the option? Effectively, this gives us an idea of how much the share price will move towards the expiration date.
Some of my readers may be wondering why we should ever bother about computing the historical volatility since these events had already happened. I have the same thoughts too until my last WAT gathering when Greekman shared with us the expected move formula and it struck me that why did I not think of that? Let me go through the computation before we move on to make some modification to the formula and see where we can go from there.
I am using the Straits Time Index (STI) as an example here to compute the historical volatility. I have done some screen captures from different issuers to show what the historical volatility of STI is after market closed today.
I am using the Straits Time Index (STI) as an example here to compute the historical volatility. I have done some screen captures from different issuers to show what the historical volatility of STI is after market closed today.
From the above screen captures, we can see that the historical volatility is around 15.01%. We are not concern about the different terms of warrant chosen as long as they all have the same underlying; their historical volatility should be approximately the same. The screen capture below is a spreadsheet where I used to compute the historical volatility of STI index. Notice the value I got is quite close to the one shown on the previous screen captures.
Let walk through how each value is being computed. Under the column with the heading showing “Straits Time Index”, the value in each of the cell shows the closing STI index value on that day. Take note that we do not include weekend or any non trading day. For example, we do not include 19th May 2008 as it is Vesak day.
Under the column with the heading showing “Percentage Change”, the value in each cell is computed based on the natural logarithm of the prior day closing index and today closing index. Take for example, the percentage change on 18th June 2008 is computed as follow, Ln(3040.09/3028.24) = 0.39%.
Once we have all the various percentage change calculated for the last 30 days, not including the one on 19th June 2008, since this is a historical volatility. To compute the historical volatility for last 30 days, we first find the standard deviation of the percentage change from 8th May 2008 to 18th June 2008 and then multiply it with the square root of 250 or 252; the number of trading days in a year. That is Stdev(-1.78%, -0.31%, 0.57% ….-0.29%, 0.39%)*Sqrt(250) = 15.02%. The reason why we multiply the standard deviation with the square root of the number of trading days is to annualize the historical volatility.
Based on the theory of statistic, if the sample is 30 and above, we can assume the distribution to be normal. This is why I have chosen 30 days and nothing less. Assuming if the STI index does follow the normal distribution, then there is a 68% of the time the STI index will fall within 2992.66 * (1 ± 15.02% * Sqrt (30/250)), which gives us a range of 2836.95 to 3148.37. We multiply the historical volatility with the Sqrt(30/250) to de-annualize it. For those who attended the last WAT gathering, do you find this formula familiar? What happen if we substitute the 2992.66 with half the current equity share price, the 15.02% with the ATM option implied volatility and the 30 with the days to expiration of the option? Effectively, this gives us an idea of how much the share price will move towards the expiration date.
I certainly hope you enjoy this as much as I do. I shall be posting the “Actual Operation of Warrant Trading (Part 4)” soon.
Monday 16 June 2008
Actual Operation of Warrant Trading (Part 3)
This is the third part of the Actual Operation of Warrant Trading. In this post, I’ll discuss about the face value of warrant. Some investors prefer warrants with a smaller face value, because they cost less to buy and the tick value is lower, and they are more sensitive to the movement of the underlying price. However, other investors prefer warrants with a bigger face value, on the grounds that, with their higher tick value, one tick will be enough to pay the brokerage commission.
So, is it a better strategy to buy warrants with smaller face value or those with a bigger face value? Lets us find it out by comparing transaction costs and how closely the warrant price will follow the movement of the underlying price.
Let us start with transaction costs. Assume that the bid/ask spread of the warrants is one tick across the board. For a warrant with a face value of no more than S$1.00, say S$0.50, the tick value is S$0.005. This is also the minimum transaction cost for buying and selling the warrant, with the underlying price remaining unchanged. For another warrant with a face value within the range between S$1.00 and S$9.99, say S$5.00, the tick value of the warrant is S$0.01. It seems that the warrant with a bigger face value is more costly. In fact, this is not true. In percentage terms, the transaction cost is actually higher for warrants with a smaller face value. In the case here, the warrant with a smaller face value, S$0.005 / S$0.50 * 100 = 1%, compared with the warrant with a bigger face value, S$0.01 / S$5.00 * 100 = 0.2%. Hence, the trading risk is relatively lower for the latter.
Besides, a warrant with a smaller face value is more likely to follow closely the movement of its underlying. Say, we have two warrants, both with a delta of 0.05 and a conversion ratio of 10:1. For the one with a smaller face value, its tick value is S$0.005. When its underlying goes up by S$0.10, the warrant will in theory, climb by 1 tick (S$0.1 * 0.05 = S$0.005). As for the warrant with a bigger face value, its tick value is S$0.01. When the underlying goes up by S$0.10, the warrant will appear to be not moving at all, as the increase in its price is less than a tick (S$0.005 = ½ tick).
Face value may be more relevant to investors looking for fast money. For ordinary investors, it does not mean much whether it is S$0.005 or S$0.01 a tick. Of course, we always want to buy something at a lower cost if possible. Nevertheless, you are advised not to be too concerned with the tick value, but spend more time studying the terms such as effective gearing, to find out the most suitable warrant for your portfolio.
So, is it a better strategy to buy warrants with smaller face value or those with a bigger face value? Lets us find it out by comparing transaction costs and how closely the warrant price will follow the movement of the underlying price.
Let us start with transaction costs. Assume that the bid/ask spread of the warrants is one tick across the board. For a warrant with a face value of no more than S$1.00, say S$0.50, the tick value is S$0.005. This is also the minimum transaction cost for buying and selling the warrant, with the underlying price remaining unchanged. For another warrant with a face value within the range between S$1.00 and S$9.99, say S$5.00, the tick value of the warrant is S$0.01. It seems that the warrant with a bigger face value is more costly. In fact, this is not true. In percentage terms, the transaction cost is actually higher for warrants with a smaller face value. In the case here, the warrant with a smaller face value, S$0.005 / S$0.50 * 100 = 1%, compared with the warrant with a bigger face value, S$0.01 / S$5.00 * 100 = 0.2%. Hence, the trading risk is relatively lower for the latter.
Besides, a warrant with a smaller face value is more likely to follow closely the movement of its underlying. Say, we have two warrants, both with a delta of 0.05 and a conversion ratio of 10:1. For the one with a smaller face value, its tick value is S$0.005. When its underlying goes up by S$0.10, the warrant will in theory, climb by 1 tick (S$0.1 * 0.05 = S$0.005). As for the warrant with a bigger face value, its tick value is S$0.01. When the underlying goes up by S$0.10, the warrant will appear to be not moving at all, as the increase in its price is less than a tick (S$0.005 = ½ tick).
Face value may be more relevant to investors looking for fast money. For ordinary investors, it does not mean much whether it is S$0.005 or S$0.01 a tick. Of course, we always want to buy something at a lower cost if possible. Nevertheless, you are advised not to be too concerned with the tick value, but spend more time studying the terms such as effective gearing, to find out the most suitable warrant for your portfolio.
Sunday 15 June 2008
Actual Operation of Warrant Trading (Part 2)
This post is a continuation from where I stopped back in April. In this post, I will discuss about the bid/ask spread or in option trading world, it is commonly known as the slippage, of warrant trading.
Let use an actual example to see if that is the case. The screen capture below shows the bid/ask price of some warrant with delta close to 100% on June 13, 2008. The next screen capture shows the buy and sell price of some counters from SGX on the same date. Noticed in the first screen capture, three out of the four warrants in the screen capture that are very close to expiration have delta close to 100%. This should be the case since the three warrants are deep ITM with around two weeks to expiration. The only warrant with a delta close to 100% and more than two months to expiration is DBS BNP ECW080905. We shall use this as an example.
Based on the second screen capture, the bid/ask spread of DBS is S$19.10 – S$19.06 = S$0.04 and the entitlement ratio is 8. This means we should expect the bid/ask spread of the warrant to be around S$0.04/8 = S$0.005. However, based on the first screen capture, the bid/ask spread for DBS BNP ECW080905 is S$0.535 - S$0.51 = S$0.025. This is 5 times more than what we expected. How about the theoretical bid/ask spread of a warrant? We can compute this by multiplying the delta of the warrant with the tick value of the underlying. Hence, the theoretical bid/ask spread for DBS BNP ECW080905 is 90.22% * S$0.02 / 8 S$0.002. Since the bid/ask spread of the warrant is also subject to the different tick values of different price ranges set by the stock exchange, we will expect the warrant bid/ask spread to be S$0.005 (the minimum bid size for price range up to S$0.99) which is consistent with the expected S$0.005 bid/ask spread we calculated earlier on. Hence we need to find out why is the actual bid/ask spread 5 times more than the theoretical spread? This will lead us to the second factor.
The second factor to consider is the liquidity of the underlying. Once a warrant is issued, the issuer has to make the necessary hedging arrangements. Buying some holdings of the underlying is one of the methods. If the liquidity of the underlying is inadequate, the cost of hedging will be high. Hence, issuers will work out an estimate of the size of the float of the underlying they can buy or sell at the optimal price before setting the bid/ask spread of the warrant.
Short term investors will find warrant trading attractive only if at least two conditions are satisfied. Firstly, there must be sufficient liquidity in the market so that warrants can easily change hands. Secondly, the bid/ask spreads must be narrow enough to keep transaction costs low. Since market making was introduced, liquidity is no longer a problem. Besides, as competition gets more and more intense, market makers are also maintaining their bid/ask spreads within a tight range. However, at times some warrants do trade with a rather wide spread. Well, then, how are bid/ask spreads determined?
The first factor to consider is delta. Given a conversion ratio of 1:1, the higher the delta (that is, close to 1 or 100%), the narrower the gap in the bid/ask spread between a warrant and its underlying. Let us say that the bid/ask spread of the underlying is S$0.02. If the warrant has a very high delta, it’s bid/ask spread will be close to S$0.02. However, if the conversion ratio is 10:1, the bid/ask spread of the warrant will be around S$0.002.
Let use an actual example to see if that is the case. The screen capture below shows the bid/ask price of some warrant with delta close to 100% on June 13, 2008. The next screen capture shows the buy and sell price of some counters from SGX on the same date. Noticed in the first screen capture, three out of the four warrants in the screen capture that are very close to expiration have delta close to 100%. This should be the case since the three warrants are deep ITM with around two weeks to expiration. The only warrant with a delta close to 100% and more than two months to expiration is DBS BNP ECW080905. We shall use this as an example.
Based on the second screen capture, the bid/ask spread of DBS is S$19.10 – S$19.06 = S$0.04 and the entitlement ratio is 8. This means we should expect the bid/ask spread of the warrant to be around S$0.04/8 = S$0.005. However, based on the first screen capture, the bid/ask spread for DBS BNP ECW080905 is S$0.535 - S$0.51 = S$0.025. This is 5 times more than what we expected. How about the theoretical bid/ask spread of a warrant? We can compute this by multiplying the delta of the warrant with the tick value of the underlying. Hence, the theoretical bid/ask spread for DBS BNP ECW080905 is 90.22% * S$0.02 / 8 S$0.002. Since the bid/ask spread of the warrant is also subject to the different tick values of different price ranges set by the stock exchange, we will expect the warrant bid/ask spread to be S$0.005 (the minimum bid size for price range up to S$0.99) which is consistent with the expected S$0.005 bid/ask spread we calculated earlier on. Hence we need to find out why is the actual bid/ask spread 5 times more than the theoretical spread? This will lead us to the second factor.The second factor to consider is the liquidity of the underlying. Once a warrant is issued, the issuer has to make the necessary hedging arrangements. Buying some holdings of the underlying is one of the methods. If the liquidity of the underlying is inadequate, the cost of hedging will be high. Hence, issuers will work out an estimate of the size of the float of the underlying they can buy or sell at the optimal price before setting the bid/ask spread of the warrant.
In the case of DBS BNP ECW080905, the delta is 90.22% and the bid/ask spread of the underlying (DBS) is S$0.04; therefore the warrant bid/ask spread should be around S$0.005. Since the conversion ratio is 8:1, this means for every 8 units of warrant the issuer needs 1 unit of DBS share to hedge its position. The outstanding warrant as on June 13, 2008 was 50, 000, 000. This is shown in the screen capture below.
Assuming this value is accurate, this means that the accumulated overnight positions, held by investors rather than the issuer at the close of trading was 50 million units. This means if the issuer needs 50 000 000/8 = 6.25 million units of DBS shares to hedge its position since the listing of this warrant.
Let’s assume due to the insufficient liquidity in the market, the issuer can only buy 6 million units of DBS shares to hedge its position at optimal price says at its average price of around S$18.80, computed based on the closing price of DBS since beginning of this year. This means the issuer has to pay an extra cost for the remaining 0.25 million units of DBS shares. If the issuer needs to pay the price of S$19.00 to buy those units for hedging, the bid/ask spread of the warrant will widen to (19.00 – 18.80)/0.02 * 0.02 * 90.22% / 8 = S$0.023 or about 5 ticks more.
The above are only assumptions made for the purpose of discussion and may not be necessary be true. Of course, sometimes an issuer may want to maintain a narrow spread for a particular warrant. So if the investors can spend a little time to observe how different issuers deal with the bid/ask spreads of their warrants, it would not be difficult to compare them and choose the most appropriate warrant to trade.
Saturday 14 June 2008
Investment Warrants
I came across this special type of warrant few months ago and I find it was quite an interesting derivative instrument that is very different from the usual plain vanilla warrant.
From what I know now is that the only issuer for Investment Warrant is Macquarie. I have gathered some information from their website and re-posted it here. If you are interested to know more, there is an upcoming free seminar on the 18th June 2008 talking about Investment Warrant. You can register here.
It’s important to remember leverage works in both directions, so a fall in the share price would also cause a greater percentage fall in the value of the warrant. It is also important to be aware that Investment Warrants will expire worthless if the share price is at or below the exercise price at expiry. 
From what I know now is that the only issuer for Investment Warrant is Macquarie. I have gathered some information from their website and re-posted it here. If you are interested to know more, there is an upcoming free seminar on the 18th June 2008 talking about Investment Warrant. You can register here.
Macquarie’s Investment Warrants allow you to get exposure to shares at a fraction of the price. With Investment Warrants you can:
- gain long term exposure for a fraction of the share price
- limit your capital at risk
- increase your effective dividend yield
Investment Warrants have longer expiry dates, lower holding costs and a lower risk profile than Trading Warrants. They are suitable for both short term and long term investment horizons.
If you recall the first post on Analysis of Warrant Data I posted in early January this year, you will notice the warrant name has an additional “I” to indicate that it is an investment warrant, e.g. COSCOCORP MBL ICW90403. Also note that by its definition, there is only investment call warrant and no such thing as investment put warrant.
What is an Investment Warrant?
An Investment Warrant enables you to buy shares in two payments. You pay a fraction of the share price up front and get exposure to the capital movements in the underlying share and all of the ordinary dividends over the life of the warrant.
Generally, the price of an Investment Warrant will move in line with movements in the underlying share and, because warrants are only a fraction of the price of the underlying share, they tend to move in greater percentages than the share price.
Investment Warrants also give you a payment equivalent to 100% of the ordinary dividends of the underlying shares. This is something that normal derivative instruments do not offer. Hence, in a way Investment Warrants therefore allow you to potentially earn a greater return than you might achieve by owning the share itself (see example below).
Investment Warrants give you:
- the right to buy a share
- at a specific price (called the exercise price)
- on a specific date (called the expiry date)
- the equivalent of 100% of the ordinary dividends throughout the life of the warrant
Investment Warrants are listed on the SGX so you can buy and sell them at any time, just like shares.
At the expiry of the warrant you have the option to either pay the exercise price and take delivery of the shares or simply receive the cash settlement amount (if any).
Benefits of Investment Warrants
- Greater return potential – through the effect of gearing, price movements are magnified
- Longer term exposure – lower holding costs mean Investment Warrants are suitable for both short and long term investments
- No Margin calls - increase your exposure to shares without the risk of margin calls
- Physical settlement – option to exercise and take delivery of the fully paid shares at expiry
- Enhanced Dividend Yield – holders receive the equivalent of 100% of the ordinary dividends of the underlying share for less outlay
Warrants enable investors to spend less up front, diversify their investments, potentially accelerate their growth and meet their investment objectives sooner.
Who would use Investment Warrants?
You might use Investment Warrants if:
- you are a long-term investor looking for a lower risk way to increase your investment returns
- you are a trader with a positive view on an underlying share and you want a moderately geared alternative
- you are an existing shareholder and want to unlock some capital from your portfolio by switching from shares into Investment Warrants
How Investment Warrants work
If you believe DBS shares will rise, you may wish to leverage your view by buying Investment Warrants over DBS shares. A hypothetical example is shown below:
Instead of purchasing the DBS share at $21.00 you can buy the Investment Warrant for only $7.30 to gain exposure to the performance of the DBS shares. During the life of the DBS Investment Warrant, the warrant price will tend to move up and down in line with the DBS share price. Investors may increase or exit their investment at any time by buying or selling the Investment Warrants on the SGX. The investor will also receive the equivalent of 100% of the ordinary dividends paid by DBS throughout this term.
At the expiry, if the investor is still holding the warrant they may either pay the exercise price of $15 and take delivery of the DBS shares or they can choose to receive the cash settlement value (if any).
- The cash settlement at expiry is calculated using the following formula:
(Share price - Exercise price) x conversion ratio - For example, if DBS is at $24 at expiry the warrant value would be:
($24.00 - $15.00) x 1 = $9.00
How gearing can boost your return
One of the main advantages of warrants is ‘gearing’, meaning a warrant provides the holder with an increased exposure to the underlying share. Therefore, a small percentage change in the price of the share can lead to a large percentage change in the value of the equity warrant.
The added advantage of Macquarie’s Investment Warrants is the increased effective dividend yield. The holder of an Investment Warrant is entitled to a payment equivalent to 100% of the ordinary dividends in the underlying share; however as the warrant price is only a fraction of the share price the effective dividend yield to the holder is increased.
Here is a hypothetical example:
It’s important to remember leverage works in both directions, so a fall in the share price would also cause a greater percentage fall in the value of the warrant. It is also important to be aware that Investment Warrants will expire worthless if the share price is at or below the exercise price at expiry. Using Investment Warrants to release capital from your portfolio
Investment warrants are a convenient and lower risk alternative to release capital from your portfolio. If you have an existing share holding you can switch into a Macquarie Investment Warrant by selling the shares and buying Warrants. By doing so you will maintain exposure to the share movements and dividends while releasing capital for other investments.
Here is a hypothetical example:
Advantages of Investment Warrants over other financing facilities
- Ability to leverage above 70%
- Limited downside
- No margin calls
There is always some risks in any kind of investment may it be stock, plain vanilla warrant or option etc. Hence the same goes for Investment Warrant. Please do some homework and understand the risks and rewards of this new derivative instrument better before risking your hard earned money in it.
Wednesday 11 June 2008
The Time Is Now
It has been almost two months since I last posted my blog entry. I must apologize to my readers who may think I have gone missing and decided not to blog again. In fact, so many things have happened within my family in these two months so much so that I feel very depress and helpless at certain point in time. But I guess I need to be strong, for my family needs me more than ever now.
My mum was diagnosed with ovarian cancer and the doctor said it is most probably in stage 3c or 4. I read up a lot on ovarian cancer since the day my mum got admitted to the hospital and I knew stage 3c and 4 are the last two stages of ovarian cancer. The gynecologist doctor who saw my mum was actually a secondary school mate of mine and he did mention to me that the prognosis of ovarian cancer is not very optimistic. At that point of time, I really cannot hold back my emotions anymore and I cried. I knew for the very fact that crying would not help and I should not have cried especially in front of my mum. But I simply cannot control myself. I cleared all my FTOs during that period of time to accompany her in the hospital. I was in the hospital early in the morning and would not leave till late at night. I know my mum needs a lot of family support especially at this point in time.
Sometimes I really wonder what have my mum done wrong to deserve this. Her life as a child was not an easy one. Being the eldest daughter in the family, she got to help out at my grandfather stall at a very young age and she did not even have a chance to go school like her other siblings. As such, she does not even know how to write her own name. Yet, as a mum of us, she has given us unconditional love throughout our bringing up, taking care of us and ensuring we are always given the best and working long hours for some miserable paycheck just so as to lessen the burden of the family. Finally when my sister got married and had her first child this year, we advised her to retire so she can help to take care of my nephew. I was happy that she can finally relax and enjoy a little after all these years of hard work and can lead a better life at old age now. But then…why should she be stricken with this? I regretted very much not bringing her to do annual checkup. I hate myself for not noticing the first time she complained about her abdomen discomfort. I am really very angry with myself.
As the day passes by and I see her getting thinner and thinner and her hairs starting to drop because of the chemotherapy she is undergoing, my heart aches a lot. The very fact that I am so helpless seeing her suffering but not able to share with her the pain she is undergoing really make me very useless. The fact that she has to take a blood test every time she goes down to the hospital made my heart aches even more. The fact that she lost her sister few years back and her father the very next year made me realized one thing - this world has not in any way be kind or fair to her. Why must her life be so tough?
I once came across a poem when I first learnt to design my own webpage and I can appreciate that poem more than ever now. I would like to share that poem here with my readers. This poem titled “The time is now”. I hope my readers would forward it to anyone who they think might benefit them in one way or another. This poem was written by a mum to her son.
THE TIME IS NOW
If you are ever going to love me
Love me now while I can know
The sweet and tender feelings
Which from true affection flow
Love me now while I am living
Do not wait until I am gone
And then have it chiseled in marble
Sweet words on ice cold stone
If you have tender thoughts of me
Please tell me now
If you wait until I am sleeping
Never will be death between us
And I won't hear you then
So if you love me, even a little bit
Let me know while I am living
So that I can treasure it
Please feel free to bless anyone with this poem. I would like to take this opportunity to thank my friends, my colleagues and my readers that have given me a lot of support and encouragement during this very tough time of mine. Due to my mum condition, I have missed out some of the WAT gatherings and I have decided to take my CFA level II exam next year instead. Lastly, I will be back blogging and sharing things I learnt. Thanks everyone.
Tuesday 15 April 2008
Actual Operation of Warrant Trading (Part 1)
It has been a really long time since I last blog. I am very sorry for my readers who visited my site and got nothing new to read. I was held up with a lot of things recently. Nevertheless, despite being busy, I have also been reading a lot on the Heston Stochastic Volatility Model and Model-Free Implied Volatility. I have dived a little more in depth on how to adjust a financial report to better value a company. There are simply too many things which I want to share as I read but I need some times to digest and further verify those things I read with real life examples before I share with my readers. As such, I have decided to continue another series of warrant trading posting but this time round, I’ll be posting on the actual operation of warrant trading.
In this posting, I’m going to discuss about the effect of tick value on warrants. With effect from 24th December 2007, SGX had revised the minimum bid sizes for its various financial instruments products. I am interested in the revised minimum bid size for securities. Under the new revised schedule, any securities trading below $1.00 have a minimum bid size of $0.005. Securities trading between $1.00 and $9.99 have a minimum bid size of $0.01. Securities trading $10.00 and above have a minimum bid size of $0.02. With this new revised minimum bid sizes in mind, I’m going to use Singapore Exchange (SGX) as an example for my discussion.
When SGX is trading at close to $10.00 in January this year, we can see that some of the warrants derived from it are lagging behind, while some others follow closely but with a bigger bid/ask spread. You can easily verify this by randomly looking at how closely the warrant price follows the stock price under the Data & Chart > Historical Price at SG Warrants. For easy reference, I have randomly capture three images for some SGX call warrants.
Assuming SGX is trading close to $10.00 at this point of time. The next tick will either bring the stock price up to $10.02 or $9.98. Hence, in this example here, a $0.02 change will mean a 0.2% increase or decrease in the underlying price. If the warrant has an effective gearing of 10 times, this $0.02 change in the underlying will be enlarged to a 2% (10 X 0.2%) change in warrant price.
Investors should understand that there exist various technical issues in the market. We should not hastily jump to the conclusion based on the varied performance of different warrants that this or that issuer is not doing a good job. The truth may boiled down to the different treatments adopted by the issuers.
In this posting, I’m going to discuss about the effect of tick value on warrants. With effect from 24th December 2007, SGX had revised the minimum bid sizes for its various financial instruments products. I am interested in the revised minimum bid size for securities. Under the new revised schedule, any securities trading below $1.00 have a minimum bid size of $0.005. Securities trading between $1.00 and $9.99 have a minimum bid size of $0.01. Securities trading $10.00 and above have a minimum bid size of $0.02. With this new revised minimum bid sizes in mind, I’m going to use Singapore Exchange (SGX) as an example for my discussion.
When SGX is trading at close to $10.00 in January this year, we can see that some of the warrants derived from it are lagging behind, while some others follow closely but with a bigger bid/ask spread. You can easily verify this by randomly looking at how closely the warrant price follows the stock price under the Data & Chart > Historical Price at SG Warrants. For easy reference, I have randomly capture three images for some SGX call warrants.
The examples I used here are not really perfect and one will be right to argue that there are some other factors (e.g. such as trading volume on that particular day) that causes the charts to be difference. Nevertheless, they are good enough to illustrate the point I’m going to discuss.
From the screen captures I have done, you will notice that for some warrants, the price of the warrant will follow very closely with that of the underlying stock while on the other hand, some of them do not follow as closely. Of course, for put warrants, the prices move in opposite direction of the underlying stock.
Assuming SGX is trading close to $10.00 at this point of time. The next tick will either bring the stock price up to $10.02 or $9.98. Hence, in this example here, a $0.02 change will mean a 0.2% increase or decrease in the underlying price. If the warrant has an effective gearing of 10 times, this $0.02 change in the underlying will be enlarged to a 2% (10 X 0.2%) change in warrant price.
Looking at another perspective, suppose we have a SGX warrant with a delta of 40% and a conversion ratio of 1:1, then for every $1.00 change in the underlying price, the warrant should, in theory, rise or fall by $0.40. So, for every $0.02 change in stock price, the warrant should move by $0.008 ($0.02 X 0.4). If the face value of the warrant is above $1.00, its tick value will be $0.01. For each tick ($0.02) of movement in the underlying price, the warrant will move by $0.008, which is not enough to make a tick in the warrant price. It appears that the warrant is lagging behind. However, if the warrant’s face value is below $1.00, its tick value will be $0.005. In this case, for every tick ($0.02) of movement in the underlying price, the warrant price will move by 1.6 ticks. Hence, if one goes for a warrant with a high delta and smaller face value, one may expect to see some movements in the warrant price.
In the face of technical issues, different issuers opt for different treatments. Some leave their warrants to swing up and down with the underlying securities, which indirectly increases the trading risk. Others take action to even out the fluctuations and make their warrants move up and down in an orderly manner (so that the warrant price will follow the underlying price to take on the ask side or the bid side). Still others choose to widen the bid/ask spreads of their warrants.
Investors should understand that there exist various technical issues in the market. We should not hastily jump to the conclusion based on the varied performance of different warrants that this or that issuer is not doing a good job. The truth may boiled down to the different treatments adopted by the issuers.
Tuesday 18 March 2008
Greeks Computation for Put Option
The day before yesterday, I posted the computation of the Greeks for call option. In today’s posting, I will continue to discuss how to do the computation of the Greeks for put option (I have purposely waited for two days to do this posting so we can see how the formulas work for us). I have also tried the formulas for the computation of Greeks for put option and compared the results to those on OptionXpress. Well, once again I cannot really say that these formulas gave very good results but they are close enough like in the case of the call option.
I am going to put down the steps for computing the Greeks for put option. You can simply follow through the steps and try out on your own if you are interested. I am going to do the Greeks for put options on the same worksheet that I used yesterday and I am going to list down the step of what you should key in each cell. If you follow exactly the cell reference I am using (which once again, I seriously encourage you to do so if you wish to try out), you should be able to just copy the formulas I have and paste them correctly into the cell reference to get the results. I am also going to include the formulas for computing the put option pricing here as well together with the computation of the Greeks.
Open the same Excel worksheet that we used yesterday, type in the following data;
I am going to put down the steps for computing the Greeks for put option. You can simply follow through the steps and try out on your own if you are interested. I am going to do the Greeks for put options on the same worksheet that I used yesterday and I am going to list down the step of what you should key in each cell. If you follow exactly the cell reference I am using (which once again, I seriously encourage you to do so if you wish to try out), you should be able to just copy the formulas I have and paste them correctly into the cell reference to get the results. I am also going to include the formulas for computing the put option pricing here as well together with the computation of the Greeks.
Open the same Excel worksheet that we used yesterday, type in the following data;
- In cell E2 and F2, perform a merge cell and type in “Put Option Pricing”.
- In cell E3, type in “Stock Symbol”. Again, I am going to use Agilent Technologies as an example; hence I am going to put the symbol “A” in cell F3.
- In cell E4, type in “Link”. Copy and paste this formula =IF(ISBLANK(F3),"",HYPERLINK("https://www.optionsxpress.com.sg/quote_detail.asp?symbol="&UPPER(F3)&"&SessionID=0",F3)) in cell F4. Hence cell F4 will update every time to provide you with the hyperlink to the stock based on the stock symbol you input in cell F3. You can click on the hyperlink to get the stock information for Agilent Technologies in this case.
- In cell E5, type in “Stock Option Chains”. Copy and paste this formula =IF(ISBLANK(F3),"",HYPERLINK("https://www.optionsxpress.com.sg/quote_option_chain.asp?SessionID=&symbol="&UPPER(F3)&"&Page=V&lstMarket=0&Range=ALL&AdjNonStdOptions=OFF&lstMonths=13",UPPER(F3)&"'s Option Chain")) in cell F5. Hence cell F5 will update every time to provide you with the hyperlink to the stock option chain based on the stock symbol you input in cell F3. You can click on the hyperlink to get the stock option chain information for Agilent Technologies in this case.
- In cell E6, type in “Option Symbol”. Type in “AQF” in cell C6. I am going to use the May 08 put option with strike price of USD$30.00 for my illustration purpose.
- In cell E7, type in “Current Stock Value”. If you have click on the hyperlink in cell F4, you should be able to get the last traded stock price for Agilent Technologies. At this point of writing, the last traded price was USD$29.67. Type in 29.67 (without the dollar sign symbol, you can format it later) in cell C7.
- In cell E8, type in “Implied Volatility”. If you have click on the hyperlink in cell F5, you should be able to get the option chain for Agilent Technologies. You should be able to find the implied volatility for AQF. At this point of writing, the implied volatility for AQF is 38.1%. Type in 38.1% (including the percentage symbol) in cell F8.
- In cell E9, copy and paste the following formula: =HYPERLINK("http://cdrates.bankaholic.com/","6-month CD rate (annualized)"). This should provide you with the hyperlink to get the 6-month CD rate (annualized). At this point of writing, due to the recent Fed rate cut, the 6-month CD rate (annualized) is 4.05%. Type in 4.05% (including the percentage symbol) in cell F9.
- In cell E10, type in “Dividend Payout per Share”. Using the same hyperlink from cell F4, you will realize that Agilent Technologies does not pay out dividend. You should see under the Dividend heading on the website with n/a. Agilent Technologies does not pay out dividend but instead they do stock repurchase from open market. Hence, type in 0 in cell F10 in this case.
- In cell E11, type in “Days to expiration”. Using the same hyperlink from cell F5 which provides you the link to the option chain for Agilent Technologies, the May 08 put option has another 60 days to expiration. Type in 60 in cell C11.
- In cell E12, type in “Strike Price”. Again, using the same hyperlink from cell F5, the strike for AQF is USD$30.00. Type in 30 (without the dollar sign symbol, you can format it later) in cell F12.
- In cell E13, type in “Put Option Price (Approximate)”. Copy and paste the formula =IF(F7<>0,-F7*EXP(-F10/F7*F11/365)*NORMSDIST(-SUM(LN(F7*EXP(-F10/F7*F11/365)/F12),SUM(F9,POWER(F8,2)/2)*F11/365)/(IF(F8=0,0.00000000001,F8)*POWER(F11/365,0.5)))+F12*EXP(-F9*F11/365)*NORMSDIST(-SUM(LN(F7*EXP(-F10/F7*F11/365)/F12),SUM(F9,POWER(F8,2)/2)*F11/365)/(IF(F8=0,0.00000000001,F8)*POWER(F11/365,0.5))+F8*POWER(F11/365,0.5)),0) in cell F13. You should get a value of USD$1.897. This is the theoretical value for the put option for AQF. At point of writing the bid-ask prices for AQF are USD$1.92 and USD$1.96 respectively. The last traded price was USD$1.85.
- I now move on to do the computation for this put option Greeks. The formula I am going to show may appear very complicated. The good thing is, you can just copy and paste them to your cell reference. I have done the tough portion for you. In cell E15, type in “Delta”. Copy and paste the following formula =NORMSDIST((LOG(F7/F12)+F11/365*(F9+0.5*F8^2))/(F8*SQRT(F11/365)))-1 in cell F15. You should get a value of -0.464. Using the link from step four, navigate to the top of the website and change the "Type" to "Pricer" and "Expiration" to "May 08" and click the "View Chain" button to get the Greeks for AQF. You need to select the “Puts” radio button too. Change the various values on the website and click on calculate. For example, in the “Current Imp Vol”, you should change to 38.1%. In the “Days Until Exp”, you should change to 60. Lastly, in the “Int Rate”, you should change the value to 4.05%. Click on the calculate button and you should get the Greeks value for all the May 08 put option updated. Leave this page as it is as we will be comparing the remaining values later. Note that the delta is -0.487 and the “Theo Value” (which is the theoretical value for the call option price) is 1.919.
- Let’s move on to do the computation for the remaining Greeks. In cell E16, type in “Gamma”. Copy and paste the following formula =EXP(-((LOG(F7/F12)+F11/365*(F9+0.5*F8^2))/(F8*SQRT(F11/365)))^2/2)/SQRT(2*PI())/F7/F8/SQRT(F11/365) in cell F16. You should get a value of 0.087. The Gamma value on the website from step 13 is 0.091.
- In cell E17, type in “Vega”. Copy and paste the following formula =F7*EXP(-((LOG(F7/F12)+F11/365*(F9+0.5*F8^2))/(F8*SQRT(F11/365)))^2/2)/SQRT(2*PI())*SQRT(F11/365)/100 in cell F17. You should get a value of 0.048. Again the Vega value on the website from step 13 is 0.048.
- In cell E18, type in “Theta”. Copy and paste the following formula =(-F7*EXP(-((LOG(F7/F12)+F11/365*(F9+0.5*F8^2))/(F8*SQRT(F11/365)))^2/2)/SQRT(2*PI())*F8/2/SQRT(F11/365)+F9*F12*EXP(-F9*F11/365)*NORMSDIST(F8*SQRT(F11/365)-((LOG(F7/F12)+F11/365*(F9+0.5*F8^2))/(F8*SQRT(F11/365)))))/365 in cell F18. You should get a value of -0.014. The Theta value on the website from step 13 is -0.014.
- Lastly, let compute the “Rho”. In cell E19, type in “Rho”. Copy and paste the following formula =-F11/365*F12*EXP(-F9*F11/365)*NORMSDIST(F8*SQRT(F11/365)-((LOG(F7/F12)+F11/365*(F9+0.5*F8^2))/(F8*SQRT(F11/365))))/100 in cell F19. You should get a value of -0.026. The Rho value on the website from step 13 is -0.027.
Once again I really hope you all enjoy this as much as I do. I hope this modeling can help you in better choosing your option in future.
Sunday 16 March 2008
Greeks Computation for Call Option
The beginning of March 2008 is a wonderful day for my family. On 1st March, my nephew had finally arrived to this world. This is really a happy occasion for my whole family. The first week of March was also my last two lessons for the Wealth Academy Trader tutorial. Unfortunately, I fell sick and I missed my fourth lesson which Conrad taught about his 5DPEG. I heard from my course mates that that the lesson was one of the most interesting of all. I am now waiting anxiously for my makeup lesson in April.
Nevertheless, I did attend the last lesson and Lawrence taught about option trading. I have some basic knowledge about option trading and its Greeks. The thing that I am not too sure is how do I make use of the Greeks? I have been waiting for this lesson to learn on the interpretation of the Greeks and most importantly, their applications. Lawrence illustrated the usage of the Greeks with examples and this has really intrigued me. My first thought in my head was then how can I compute the Greeks myself and how can I apply them to warrant trading? The next thing I was asking myself is the relationship between historical and implied volatility. I have figured out how I can compute the historical and implied volatility but I do not know if there is a relationship between them?
I actually went on to do my own research on the computation of the Greeks and the relationship between historical and implied volatility. Well, my hard work did pay off and I manage to find the ways to compute the Greeks but unfortunately, the relationship between historical and implied volatility is not so straight forward and it required the understanding of regression model to understand how the relationship is being model. Furthermore, I believe the parameters to the model have to be tuned and changed accordingly as time goes by and whenever the underlying of the model is changed. As such, I decided to post my finding of the computation of the Greeks which can be easily done using Microsoft Excel.
I have tried the formulas for the computation of Greeks and compared the results to those on OptionXpress. Well, I cannot really said that these formulas gave very good results as compared with my previous posting of option pricing using the Black Scholes formula but at times they gave very close estimates. I have been trying to figure out how can I use these same formulas to compute the Greeks for warrant trading? This is because information on warrant Greeks is not so easily available as compared with option. Sad to say, I did not succeed. My original intention was to blog on how we can compute the Greeks for warrant? This also explains why I have not been blogging for so long. Hence I decided that I should post my finding on the computation of the Greeks for option and perhaps some of my readers can go ahead and figure out how to do so for warrant and it would be great if he or she can share the finding with us.
I am going to put down the steps for computing the Greeks for option. You can simply follow through the steps and try out on your own if you are interested. I am going to do both the Greeks for call and put options on the same worksheet and I am going to list down the step of what you should key in each cell. If you follow exactly the cell reference I am using (which I seriously encourage you to do so if you wish to try out), you should be able to just copy the formulas I have and paste them correctly into the cell reference to get the results. I am also going to include the formulas for computing the option pricing here together with the computation of the Greeks.
I will start doing with the Call option first and later for the Put option in another posting. Open an Excel workbook and on one of the worksheets, type in the following data;
- In cell B2 and C2, perform a merge cell and type in “Call Option Pricing”.
- In cell B3, type in “Stock Symbol”. I am going to use Agilent Technologies as an example; hence I am going to put the symbol “A” in cell C3.
- In cell B4, type in “Link”. Copy and paste this formula =IF(ISBLANK(C3),"",HYPERLINK("https://www.optionsxpress.com.sg/quote_detail.asp?symbol="&UPPER(C3)&"&SessionID=0",C3)) in cell C4. Hence cell C4 will update every time to provide you with the hyperlink to the stock based on the stock symbol you input in cell C3. You can click on the hyperlink to get the stock information for Agilent Technologies in this case.
- In cell B5, type in “Stock Option Chains”. Copy and paste this formula =IF(ISBLANK(C3),"",HYPERLINK("https://www.optionsxpress.com.sg/quote_option_chain.asp?SessionID=&symbol="&UPPER(C3)&"&Page=V&lstMarket=0&Range=ALL&AdjNonStdOptions=OFF&lstMonths=13",UPPER(C3)&"'s Option Chain")) in cell C5. Hence cell C5 will update every time to provide you with the hyperlink to the stock option chain based on the stock symbol you input in cell C3. You can click on the hyperlink to get the stock option chain information for Agilent Technologies in this case.
- In cell B6, type in “Option Symbol”. Type in “AEF” in cell C6. I am going to use the May 08 call option with strike price of USD$30.00 for my illustration purpose.
- In cell B7, type in “Current Stock Value”. If you have click on the hyperlink in cell C4, you should be able to get the last traded stock price for Agilent Technologies. At this point of writing, the last traded price was USD$29.64. Type in 29.64 (without the dollar sign symbol, you can format it later) in cell C7.
- In cell B8, type in “Implied Volatility”. If you have click on the hyperlink in cell C5, you should be able to get the option chain for Agilent Technologies. You should be able to find the implied volatility for AEF. At this point of writing, the implied volatility for AEF is 36.9%. Type in 36.9% (including the percentage symbol) in cell C8.
- In cell B9, copy and paste the following formula: =HYPERLINK("http://cdrates.bankaholic.com/","6-month CD rate (annualized)"). This should provide you with the hyperlink to get the 6-month CD rate (annualized). At this point of writing, due to the recent Fed rate cut, the 6-month CD rate (annualized) is 4.05%. Type in 4.05% (including the percentage symbol) in cell C9.
- In cell B10, type in “Dividend Payout per Share”. Using the same hyperlink from cell C4, you will realize that Agilent Technologies does not pay out dividend. You should see under the Dividend heading on the website with n/a. Agilent Technologies does not pay out dividend but instead they do stock repurchase from open market. Hence, type in 0 in cell C10 in this case.
- In cell B11, type in “Days to expiration”. Using the same hyperlink from cell C5 which provides you the link to the option chain for Agilent Technologies, the May 08 call option has another 62 days to expiration. Type in 62 in cell C11.
- In cell B12, type in “Strike Price”. Again, using the same hyperlink from cell C5, the strike for AEF is USD$30.00. Type in 30 (without the dollar sign symbol, you can format it later) in cell C12.
- In cell B13, type in “Call Option Price (Approximate)”. Copy and paste the formula =IF(C7<>0,C7*EXP(-C10/C7*C11/365)*NORMSDIST(SUM(LN(C7*EXP(-C10/C7*C11/365)/C12),SUM(C9,POWER(C8,2)/2)*C11/365)/(IF(C8=0,0.00000000001,C8)*POWER(C11/365,0.5)))-C12*EXP(-C9*C11/365)*NORMSDIST(SUM(LN(C7*EXP(-C10/C7*C11/365)/C12),SUM(C9,POWER(C8,2)/2)*C11/365)/(IF(C8=0,0.00000000001,C8)*POWER(C11/365,0.5))-C8*POWER(C11/365,0.5)),0) in cell C13. You should get a value of USD$1.725. This is the theoretical value for the call option for AEF. At point of writing the bid-ask prices for AEF are USD$1.64 and USD$1.77 respectively. The last traded price was USD$1.73.
- I now move on to do the computation for this call option Greeks. The formula I am going to show may appear very complicated. The good thing is, you can just copy and paste them to your cell reference. I have done the tough portion for you. In cell B15, type in “Delta”. Copy and paste the following formula =NORMSDIST((LOG(C7/C12)+C11/365*(C9+0.5*C8^2))/(C8*SQRT(C11/365))) in cell C15. You should get a value of 0.535. Using the link from step four, navigate to the top of the website and change the "Type" to "Pricer" and "Expiration" to "May 08" and click the "View Chain" button to get the Greeks for AEF. Change the various values on the website and click on the "Calculate" button. For example, in the “Current Imp Vol”, you should change to 36.9%. In the “Days Until Exp”, you should change to 62. Lastly, in the “Int Rate”, you should change the value to 4.05%. Click on the "Calculate" button and you should get the Greeks value for all the May 08 call option updated. Leave this page as it is as we will be comparing the remaining values later. Note that the delta is 0.517 and the “Theo Value” (which is the theoretical value for the call option price) is 1.729.
- Let’s move on to do the computation for the remaining Greeks. In cell B16, type in “Gamma”. Copy and paste the following formula =EXP(-((LOG(C7/C12)+C11/365*(C9+0.5*C8^2))/(C8*SQRT(C11/365)))^2/2)/SQRT(2*PI())/C7/C8/SQRT(C11/365) in cell C16. You should get a value of 0.089. The Gamma value on the website from step 13 is 0.091.
- In cell B17, type in “Vega”. Copy and paste the following formula =C7*EXP(-((LOG(C7/C12)+C11/365*(C9+0.5*C8^2))/(C8*SQRT(C11/365)))^2/2)/SQRT(2*PI())*SQRT(C11/365)/100 in cell C17. You should get a value of 0.049. Again the Vega value on the website from step 13 is 0.049.
- In cell B18, type in “Theta”. Copy and paste the following formula =(-C7*EXP(-((LOG(C7/C12)+C11/365*(C9+0.5*C8^2))/(C8*SQRT(C11/365)))^2/2)/SQRT(2*PI())*C8/2/SQRT(C11/365)-C9*C12*EXP(-C9*C11/365)*NORMSDIST(((LOG(C7/C12)+C11/365*(C9+0.5*C8^2))/(C8*SQRT(C11/365)))-C8*SQRT(C11/365)))/365 in cell C18. You should get a value of -0.016. The Theta value on the website from step 13 is -0.016.
- Lastly, let compute the “Rho”. In cell B19, type in “Rho”. Copy and paste the following formula =C11/365*C12*EXP(-C9*C11/365)*NORMSDIST(((LOG(C7/C12)+C11/365*(C9+0.5*C8^2))/(C8*SQRT(C11/365)))-C8*SQRT(C11/365))/100 in cell C19. You should get a value of 0.024. The Rho value on the website from step 13 is 0.023.
I hope you all enjoy this as much as I do. Please do not delete away the spreadsheet as I will use the same one to illustrate the computation for the put option in my later post. For those who understand and trade options and warrants, you will appreciate more and how this modeling exercise can help you better in choosing your option.
Friday 29 February 2008
Analysis of Warrant Data (Part 8)
Today is the 29th of February 2008. I suppose you know this day only comes once every four years. This year is a leap year. I am not too sure if you know there is also something known as the leap century which occurs once every four hundred years. Something interesting about the leap century is that the 1st of January of a leap century always falls on a Saturday. You can easily verify this with a perpetual calendar if you are interested. The last leap year was 2004 and the last leap century was 2000. We have to wait for another four years till 2012 for another leap year and 2400 for another leap century. I do not think I will see that year coming.
Theta
In warrant, there is the effect of time as well and you do not have the luxury of another four years. The Greek used to measure time is known as theta. Theta, also called time decay, measures the rate of change in the price of a warrant as its maturity is running short while all other things being equal. It can be expressed as an absolute value or a percentage relative to the warrant price (theta / warrant price). Unless in some special circumstances, the value of theta is usually negative, reflecting the declining value of a warrant as time passes. The time decay has its greatest effect when the warrant is near to its maturity. Time decay accelerates as time passes.
In percentage terms, time value has the biggest impact on out-of-the-money (OTM) warrants. The value of a warrant consists of intrinsic value and time value. They vary in absolute and relative terms for warrants with different strike prices and maturity dates. In the case of OTM warrants, their intrinsic values are negligible or zero. In other words, time value makes up most of their values. Hence, they are more sensitive to the passage of time. As for the in-the-money (ITM) warrants, given that a large part of their value is made up of intrinsic value, they are less sensitive to the passage of time, and such sensitivity decreases as the maturity date gets nearer.
Investors should find out more about the theta of a warrant as a percentage relative to its price, that is, relative theta. The latter is a better indicator to the sensitivity of a warrant to the passage of time, and will give you a better idea about the effect of time value on the gain or loss on warrants you are holding.
Vega
Vega measures the rate of change in the warrant price for each point of movement of its implied volatility. No matter it is a call warrant or a put warrant, Vega is always positive, indicating that the warrant price and its implied volatility always move in the same direction. Vega can be an absolute value or a percentage relative to the warrant price.
In terms of the percentage change in price, changes in implied volatility have the biggest impact on OTM warrants. Besides, the closer they get to the maturity, the bigger the impact. Next come at-the-money (ATM) warrants, and then ITM warrants. For the latter, the closer they get to maturity, the smaller the impact. Hence, in picking warrant, investors should check out its Vega as a percentage relative to change in warrant price, in order to assess the impact of implied volatility on the warrant.
Gamma
Gamma measures the sensitivity of the delta of a warrant to the price movements of its underlying. The higher the gamma, the bigger the change in delta will be in reaction to a movement in the underlying price.
Gamma = rate of change of delta / rate of change of underlying price
No matter it is a call warrant or put warrant, gamma is always positive. When the underlying goes up, in the case of a call warrant, its delta will go up as it is more likely to be ITM; in the case of a put warrant, the same will happen too as it is more likely to be OTM and its delta will get closer to zero.
ATM warrants (for those with maturity of less than a year) have the highest gamma. This means that they have the highest rate of change of delta.
Rho
Rho measures the sensitivity of warrant price to changes in the market interest rate. Call warrants have a positive rho, meaning that the price of a call warrant moves in the same direction as the market interest rate. In contrast, put warrants have a negative rho, and this shows that the price of a put warrant moves in the opposite direction to the market interest rate. Given that changes in interest rates tend to be limited in the short term, their effect on warrant prices is minimal.
This is my last post on analysis of warrant data. What I have discussed above is known as the Greeks of warrant. They look quite similar to those of option. The Greeks are important in trading both warrants and options. Unfortunately, the information for the Greeks for warrants are not easily available as compared with options.
Theta
In warrant, there is the effect of time as well and you do not have the luxury of another four years. The Greek used to measure time is known as theta. Theta, also called time decay, measures the rate of change in the price of a warrant as its maturity is running short while all other things being equal. It can be expressed as an absolute value or a percentage relative to the warrant price (theta / warrant price). Unless in some special circumstances, the value of theta is usually negative, reflecting the declining value of a warrant as time passes. The time decay has its greatest effect when the warrant is near to its maturity. Time decay accelerates as time passes.
In percentage terms, time value has the biggest impact on out-of-the-money (OTM) warrants. The value of a warrant consists of intrinsic value and time value. They vary in absolute and relative terms for warrants with different strike prices and maturity dates. In the case of OTM warrants, their intrinsic values are negligible or zero. In other words, time value makes up most of their values. Hence, they are more sensitive to the passage of time. As for the in-the-money (ITM) warrants, given that a large part of their value is made up of intrinsic value, they are less sensitive to the passage of time, and such sensitivity decreases as the maturity date gets nearer.
Investors should find out more about the theta of a warrant as a percentage relative to its price, that is, relative theta. The latter is a better indicator to the sensitivity of a warrant to the passage of time, and will give you a better idea about the effect of time value on the gain or loss on warrants you are holding.
Vega
Vega measures the rate of change in the warrant price for each point of movement of its implied volatility. No matter it is a call warrant or a put warrant, Vega is always positive, indicating that the warrant price and its implied volatility always move in the same direction. Vega can be an absolute value or a percentage relative to the warrant price.
In terms of the percentage change in price, changes in implied volatility have the biggest impact on OTM warrants. Besides, the closer they get to the maturity, the bigger the impact. Next come at-the-money (ATM) warrants, and then ITM warrants. For the latter, the closer they get to maturity, the smaller the impact. Hence, in picking warrant, investors should check out its Vega as a percentage relative to change in warrant price, in order to assess the impact of implied volatility on the warrant.
Gamma
Gamma measures the sensitivity of the delta of a warrant to the price movements of its underlying. The higher the gamma, the bigger the change in delta will be in reaction to a movement in the underlying price.
Gamma = rate of change of delta / rate of change of underlying price
No matter it is a call warrant or put warrant, gamma is always positive. When the underlying goes up, in the case of a call warrant, its delta will go up as it is more likely to be ITM; in the case of a put warrant, the same will happen too as it is more likely to be OTM and its delta will get closer to zero.
ATM warrants (for those with maturity of less than a year) have the highest gamma. This means that they have the highest rate of change of delta.
Rho
Rho measures the sensitivity of warrant price to changes in the market interest rate. Call warrants have a positive rho, meaning that the price of a call warrant moves in the same direction as the market interest rate. In contrast, put warrants have a negative rho, and this shows that the price of a put warrant moves in the opposite direction to the market interest rate. Given that changes in interest rates tend to be limited in the short term, their effect on warrant prices is minimal.
This is my last post on analysis of warrant data. What I have discussed above is known as the Greeks of warrant. They look quite similar to those of option. The Greeks are important in trading both warrants and options. Unfortunately, the information for the Greeks for warrants are not easily available as compared with options.
Thursday 28 February 2008
Analysis of Warrant Data (Part 7)
I went for a MSDN Tech-Talk held by Microsoft yesterday at One Marina Boulevard in the NTUC Auditorium. I was particularly impressed by the SQL Server 2008 that is going to be release soon in March. There is this Data analysis feature available since SQL Server 2005 and this is really a very powerful feature I would say. You can download a plug-in for Microsoft Excel 2007 and made used of this data analysis feature that comes with the developer, standard and enterprise version of the SQL Server 2005 and 2008 to perform time series regression to forecast short term and long term trend of data available in either the SQL Server or Microsoft Excel 2007. The plug-in also allows you to generate a report formatted with visual cue that made interpreting the data much easier.
I will be testing out the feature once I can get the SQL Server analysis service to setup on my computer. Meanwhile in today’s posting, I am going to continue on the Analysis of warrant data. I have been busy preparing my CFA level II examination and hence have not been updating my blog as regularly. This is the second last post on Analysis of warrant data which I will talk about Delta.
Put simply, delta measures how much, in theory, the warrant price will move for a $1.00 change in the underlying price (For me, I treat this as the first derivative of warrant price, typical engineer thought). For investors, delta is meaningful in the following aspects:
Relationship between delta and ITM/ATM/OTM
Call warrants have a positive delta, which means that the underlying price and the warrant price move in the same direction. On contrary, put warrants have a negative delta, which means that the underlying price and the warrant price move in opposite direction.
The value of delta lies between 0 and 1 for a call warrant, and between 0 and -1 for a put warrant. When a call warrant is at-the-money (ATM), its delta should be around 0.5. This value will move closer to 1 in the case the warrant becomes deeper in-the-money (ITM), or closer to 0 in the case the warrant moves further out-of-the-money (OTM). For a put warrant, when it is ATM, its delta should be around -0.5. Likewise, this value will move closer to -1 in case the warrant becomes deeper ITM or closer to 0 in case the warrant moves further OTM.
Delta reflects the degree of probability that a warrant will be ITM at maturity. A far OTM warrant has a delta close to 0, indicating almost zero chance that it will become ITM at maturity. An ATM warrant has a delta of around 0.5 and there is about 50% chance that the warrant will become ITM at maturity. A deep ITM warrant has a delta close to 100%, and this means there is nearly 100% chance that the warrant will stay ITM at maturity.
Prediction of changes in the warrant price
In general, investors can use delta to predict how much the warrant is likely to move for a $1.00 change in the underlying price. Say, for example, UOB BNP ECW100319 has a delta of 0.7468 after market closed yesterday. The conversion ratio is 14.993. The closing price for UOB was $18.42 yesterday. If the underlying price goes up by $1.00, the warrant price should, in theory, rise by $1.00 * 0.7468 / 14.993 = $0.05.
In reality, when the underlying price goes up or down by $1.00, the warrant is unlikely to move by the exact amount suggested by its delta, which is not a constant, but a variable. It will vary along with the underlying price, implied volatility and days to maturity. For example, assuming that the underlying price remains constant, with its time value or implied volatility falling, an OTM warrant will see a decline in its delta while an ITM warrant will see a rise. Usually, investors focus only on the relationship between delta and changes in the underlying price, and neglect the effect of changes in the implied volatility and time value.
Besides, the price of a warrant is determined by the market, and will be affected by market sentiments, market making activities, and the outstanding quantity of warrant. Hence, warrant usually trade at a level different from the theoretical price suggested by its delta.
Finding out the number of units of the warrant to be bought
Investors can also use delta to roughly estimate how many units of a warrant should be bought to reap a potential return close to that from a given units of the underlying. For example, a certain investor is optimistic about the UOB counter and wants to invest with a smaller amount of capital. If the investor wants to get an exposure to 1000 shares of UOB stock, using the previous warrant as an example, the delta is 0.7468, the number of units of warrant the investor should buy is equal to 1000 (the number of shares) divided by 0.7468 (the delta of the warrant), that is, 1340 units.
Finding out the number of units of new warrant to be bought for switching
Besides, investors can also use delta to roughly estimate how many units of a warrant need to be bought for switching to maintain the potential return. If the warrant on hand is about to expire or is going further OTM, one should consider switching. To find out how to use delta to calculate the number of units of the new warrant that need to be bought to replace the old warrant in order to maintain potential return at the original level, we can simply divide the delta of the warrant we intend to switch with that of the warrant we are switching to.
For example, CAPITALAND DB ECW080616 and CAPITALAND DB ECW080616 A have a strike of $7.30 and $6.30 respectively. Both have a conversion ratio of 5:1 and same maturity date. At point of writing, CapitaLand has a price of $6.62. Hence CAPITALAND DB ECW080616 A is ITM and CAPITALAND DB ECW080616 is OTM. CAPITALAND DB ECW080616 A has a delta of 63.27% and an effective gearing of 5.08x while CAPITALAND DB ECW080616 has a delta of 43.11% and an effective gearing of 5.44x. We noticed that CapitaLand share price has been going up for at least the past two weeks and says we remain positive that CapitaLand will move further up in price for next two weeks. Hence we want to switch from CAPITALAND DB ECW080616 A to CAPITALAND DB ECW080616 since it has a higher effective gearing even though CAPITALAND DB ECW080616 A has a higher delta. Therefore, we need to buy 63.27/43.11 = 1.46 units of CAPITALAND DB ECW080616 for each unit of CAPITALAND DB ECW080616 A to maintain the potential return.
You may ask, since the potential profit remains more or less the same, why should be bothered with switching at all? Why should we pay the additional transaction costs for selling CAPITALAND DB ECW080616 A and buying CAPITALAND DB ECW080616?
The purpose of switching is to allow us to sell a warrant with a higher price for another warrant with a higher effective gearing so as to invest with less capital for better utilization of funds. We do not have to be bound by the switching ratio, but it will give us an idea about how many units of new warrant we should buy to maintain potential profit as the same level.
The examples given are for illustration purpose and not my recommendation. I have tried to use real examples to illustrate my points. I will be positing my last post on analysis of warrant data soon.
I will be testing out the feature once I can get the SQL Server analysis service to setup on my computer. Meanwhile in today’s posting, I am going to continue on the Analysis of warrant data. I have been busy preparing my CFA level II examination and hence have not been updating my blog as regularly. This is the second last post on Analysis of warrant data which I will talk about Delta.
Put simply, delta measures how much, in theory, the warrant price will move for a $1.00 change in the underlying price (For me, I treat this as the first derivative of warrant price, typical engineer thought). For investors, delta is meaningful in the following aspects:
Relationship between delta and ITM/ATM/OTM
Call warrants have a positive delta, which means that the underlying price and the warrant price move in the same direction. On contrary, put warrants have a negative delta, which means that the underlying price and the warrant price move in opposite direction.
The value of delta lies between 0 and 1 for a call warrant, and between 0 and -1 for a put warrant. When a call warrant is at-the-money (ATM), its delta should be around 0.5. This value will move closer to 1 in the case the warrant becomes deeper in-the-money (ITM), or closer to 0 in the case the warrant moves further out-of-the-money (OTM). For a put warrant, when it is ATM, its delta should be around -0.5. Likewise, this value will move closer to -1 in case the warrant becomes deeper ITM or closer to 0 in case the warrant moves further OTM.
Delta reflects the degree of probability that a warrant will be ITM at maturity. A far OTM warrant has a delta close to 0, indicating almost zero chance that it will become ITM at maturity. An ATM warrant has a delta of around 0.5 and there is about 50% chance that the warrant will become ITM at maturity. A deep ITM warrant has a delta close to 100%, and this means there is nearly 100% chance that the warrant will stay ITM at maturity.
Prediction of changes in the warrant price
In general, investors can use delta to predict how much the warrant is likely to move for a $1.00 change in the underlying price. Say, for example, UOB BNP ECW100319 has a delta of 0.7468 after market closed yesterday. The conversion ratio is 14.993. The closing price for UOB was $18.42 yesterday. If the underlying price goes up by $1.00, the warrant price should, in theory, rise by $1.00 * 0.7468 / 14.993 = $0.05.
In reality, when the underlying price goes up or down by $1.00, the warrant is unlikely to move by the exact amount suggested by its delta, which is not a constant, but a variable. It will vary along with the underlying price, implied volatility and days to maturity. For example, assuming that the underlying price remains constant, with its time value or implied volatility falling, an OTM warrant will see a decline in its delta while an ITM warrant will see a rise. Usually, investors focus only on the relationship between delta and changes in the underlying price, and neglect the effect of changes in the implied volatility and time value.
Besides, the price of a warrant is determined by the market, and will be affected by market sentiments, market making activities, and the outstanding quantity of warrant. Hence, warrant usually trade at a level different from the theoretical price suggested by its delta.
Finding out the number of units of the warrant to be bought
Investors can also use delta to roughly estimate how many units of a warrant should be bought to reap a potential return close to that from a given units of the underlying. For example, a certain investor is optimistic about the UOB counter and wants to invest with a smaller amount of capital. If the investor wants to get an exposure to 1000 shares of UOB stock, using the previous warrant as an example, the delta is 0.7468, the number of units of warrant the investor should buy is equal to 1000 (the number of shares) divided by 0.7468 (the delta of the warrant), that is, 1340 units.
Finding out the number of units of new warrant to be bought for switching
Besides, investors can also use delta to roughly estimate how many units of a warrant need to be bought for switching to maintain the potential return. If the warrant on hand is about to expire or is going further OTM, one should consider switching. To find out how to use delta to calculate the number of units of the new warrant that need to be bought to replace the old warrant in order to maintain potential return at the original level, we can simply divide the delta of the warrant we intend to switch with that of the warrant we are switching to.
For example, CAPITALAND DB ECW080616 and CAPITALAND DB ECW080616 A have a strike of $7.30 and $6.30 respectively. Both have a conversion ratio of 5:1 and same maturity date. At point of writing, CapitaLand has a price of $6.62. Hence CAPITALAND DB ECW080616 A is ITM and CAPITALAND DB ECW080616 is OTM. CAPITALAND DB ECW080616 A has a delta of 63.27% and an effective gearing of 5.08x while CAPITALAND DB ECW080616 has a delta of 43.11% and an effective gearing of 5.44x. We noticed that CapitaLand share price has been going up for at least the past two weeks and says we remain positive that CapitaLand will move further up in price for next two weeks. Hence we want to switch from CAPITALAND DB ECW080616 A to CAPITALAND DB ECW080616 since it has a higher effective gearing even though CAPITALAND DB ECW080616 A has a higher delta. Therefore, we need to buy 63.27/43.11 = 1.46 units of CAPITALAND DB ECW080616 for each unit of CAPITALAND DB ECW080616 A to maintain the potential return.
You may ask, since the potential profit remains more or less the same, why should be bothered with switching at all? Why should we pay the additional transaction costs for selling CAPITALAND DB ECW080616 A and buying CAPITALAND DB ECW080616?
The purpose of switching is to allow us to sell a warrant with a higher price for another warrant with a higher effective gearing so as to invest with less capital for better utilization of funds. We do not have to be bound by the switching ratio, but it will give us an idea about how many units of new warrant we should buy to maintain potential profit as the same level.
The examples given are for illustration purpose and not my recommendation. I have tried to use real examples to illustrate my points. I will be positing my last post on analysis of warrant data soon.
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