Very good article for us what's put warrants on ST index.
LAST Monday's column highlighted how call warrants on the STI work, these being useful trading instruments for short-term punters keen to capitalise on near-term strength in the index.
This week's focus is on put warrants, instruments that are useful for traders who wish to profit from near-term weakness in the index. The principles governing the workings of puts are the same as calls but because most people are not accustomed to thinking about an instrument that gains value in a falling market, there is often confusion over how to perform the calculations correctly.
A put on the index gives the holder the right to sell the underlying index to the issuer at a fixed price within the warrant's life span. So if the index falls below this exercise price, the holder can in theory exercise the put, buy the index at the market price, sell it to the issuer and pocket the difference.
In practice, this kind of exercise only occurs at expiry and no actual exchange of the index (or any other asset as the case may be) takes place. Instead, if the index stands below the put's exercise price at expiry, the issuer will simply pay holders the difference.
Notice that because puts gain value in a falling market, the further below the exercise price the index falls, the more money holders make or the more 'in-the-money' the put becomes. Conversely, if the index rises above the exercise price, the instrument is said to be intrinsically worthless or 'out-of-the-money'.
Exercise price
There are currently five put warrants on the ST Index, all issued by SG Securities and bearing exercise prices ranging from 2,800 to 3,300 (details are available at www.warrants.com).
The ST Index ended at 3,068.75 on Friday, so the puts with exercise prices of 3,150 and 3,300 are the only two that are in-the-money while the other three are out-of-the-money.
The closest to the index's present reading is the put with exercise (or strike) price of 3,150 and is given as STI3150SGAePW070427 which reading from left to right is 'STI Index, 3,150 exercise price, issued by SG, put warrant, expiring 2007 April 27'.
Note that 300 warrants are needed to convert to one index value. Someone who buys at Friday's closing of 52.5 cents and holds the warrant until expiry next month will break even when the index falls to 2,992 (3,150-300(0.525)).
In other words, if the index is at 2,992 on the last trading day of 23 April, SG will have to pay 52.5 cents to each warrant holder. The 2,992 level is given under 'break-even price' on the website. (Of course, if the index is lower than 2,992, the payout is even greater).
An index at 3,068.75 means a put warrant with an exercise price of 3,150 is in-the-money to the tune of 81.25 points (3,150-3,068.75). Looked at differently, the index would have to rise 81.25 points or 2.648 per cent before the warrant loses its in-the-money status. This appears on the website as 'Moneyness: 2.648% ITM'.
Compare this to the put with a strike price of 3,000, a figure that is below the current index and so means the warrant is out-of-the-money. In order for this instrument to move in-the-money, the index would have to fall by at least (3,068.75 - 3,000) or 68.75 points. In percentage terms, this is 2.24 per cent and this figure can be seen under 'Moneyness: 2.24% OTM'.
As with calls, time is a very important consideration, as are variables such as theta (rate of time decay), delta (movement in warrant for a unit move in the underlying index) and vega (sensitivity to changes in volatility) which are typically used by more advanced traders but are nevertheless useful to all traders who seek to figure out how the instrument might behave in the near term.
A final word about the resistance many people have to buying puts when they think the market is about to fall. For some odd psychological reason, traders tend to avoid trading puts and even go so far as to short-sell calls when they want to profit from a falling market.
Shorting calls is a highly risky strategy - if the market bounces suddenly, the trader is exposed to theoretically unlimited loss. As such, it is not recommended. So if you think the days ahead might remain weak and believe the best way to make money from this is by using warrants, we'd recommend using the put route.
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