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 }

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.

  1. 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.
  2. 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.
  3. For BNP Paribas (BNP), the settlement for the STI is based on the five days average closing price of STI.
  4. For Macquarie Capital Securities (MBL), there is no warrant issued for STI that I can find.
  5. 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.

  1. For Société Générale (SGA), the settlement details can be found here.
  2. For Deutsche Bank (DB), the settlement details can be found here.
  3. For BNP Paribas (BNP), the settlement details can be found here.
  4. For Macquarie Capital Securities (MBL), the settlement details can be found here.
  5. 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.


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