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Introduction to the Warrant Market in HK
In the Hong Kong Securities market, besides the more than 500 stocks that
are available, there are also more than 200 warrants which provide
excellent investment opportunity for both long term and speculative
investors.
Principles of Warrant
For every warrant, there is an expiration date and also a strike
price. For example, for the New World Development (017), it has
a warrant 319 expiring on May 12, 1995, the strike price being
$14.70. It means that on any date before May 12, 1995, any
warrant holder can go to the share registrar of New World
Development and get one share of the New World Development by
exercising one warrant together with the payment of $14.70, no
matter what the current price of the share it may be.
For some other warrants, the conversion ratio of stock to warrant
is not one to one. For example, the warrant for Peregrine (370) has
an expiration date on March 31, 1995. The strike price is 8.34, and
the conversion ratio 0.24 (i.e. 1 warrant can only be converted
to 0.24 share).
Mathematically,
Exercise price (E) = Strike price (K) +
price of warrant (W) / conversion ratio (R)
Say if an investor is optimistic on New World Development (NWD),
and he anticipates that it will rise from $20.0 to $25.0 in a
short time.
He may either:
. invest $20000. to buy 1000 shares of NWD. When it really hits
$25, he gets $5000 (i.e. 25%) profit. Or he can
. invest $5000. to buy 1000 warrants of NWD (319). When NWD rises to
to $25., the warrant also goes up to $10. He gets again $5000 profit,
but it represents 100% profit!
Premium and Leverage Ratio
As an investor can gain the same amount of profit by using less
capital through investment in the warrant market, investors
would like to pay more in buying warrants, especially for those
warrants that have a longer expiration date. So the Exercise
price (E) is in most of the time higher than that of current
price of stock (S).
To estimate the over-price ratio of the warrant, a factor called
premium is defined :
Premium = (Exercise price / current price of stock - 1) x 100%
= ( ( K + W/R ) / S - 1 ) * 100%
For blue chip warrant, the normal premium ratio is as followed:
expiration dat premium (%)
1 - 2 years 20-30%
.5 - 1 year 7-15%
2 - 4 months 3- 6%
1 - 2 months 1- 3%
less than 1 week < -3%
This is just a rough estimation of figure. It should be noted
that when a warrant is going to be expired, the premium can be
as low as -3%. It is because the holder has to get some larger
amount of capital to exer cise the warrant. The newly issued
warrant normally will only be available after 4 weeks time, and
the investor has to bear the possible risk for the fluctuation
of this stock within this 4 weeks. (Suppose the share of NWD has
dropped continuously to $16, but as the new stocks are not
available yet, the investor cannot sell it to cut loss). Another
important parameter is the likely magnification factor for the
variation in price of warrant with respect to the stock. Again
taking the NWD as example, if the price of stock is $20.0 and
the warrant (319) is $5.0. When the price of stock goes up
$0.10, and the warrant also goes up $0.10. So the leverage
ratio (L) is 4. i.e. Leverage ratio (L) = dS / dW = S / W but
for those warrant with conversion ratio not equal t>o 1,
Leverage ratio (L) = S / (W/R)
= S x R / W
The Leverage ratio will be the highest when the stock price is
approaching that of the strike price, since the price of warrant
will be approaching zero in this case.
It is common that a share can have several warrants (for instance,
HK Bank has 8 warrants). If an investor is optimistic in the
stock but he would like to invest on the warrant, he should choose
a warrant that has:
. longer expiration date
. low premium
. high leverage ratio
. higher daily turnover
Pros and Cons in invest in Warrant vs that of Stocks
The following factors should be noted when an investor is considering
for investment in the warrant market:
(1) Higher risk
As mentioned above, if the leverage ratio for a warrant is 10, then
will rise 10%. However, it can also drop for 10% if the corresponding
stock drops for 1%.
(2) Difficulty in buy/sell and the much wider spread
Due to the much smaller warrant market, it is very common that if
you determine to buy, you find no seller; and if you want to sell,
you can't find any buyer.
It is also not uncommon that you find the buy/sell spread is
totally
impossible for trading, for instance the buyer may ask for a price of
$1.40 whereas the seller asks for a price of $1.70! It is true that
the HKSE computer system will only allow for quoting a maximum of
5 positions from the last dealing price, but the market speculators can
just legally mark up/down the price using some market tricks.
(Say you want to buy 20000 at $1.40. Someone just places 1 lot of 2000
at a price of $1.45 for sell. He asks one of his colleague to take
it immediately at that $1.45 price. Again, he places out another
lot of 2000 at $1.50 which is entirely legal because the last dealing
price was at $1.45. Similarly, his friend just takes it as soon
as this lot is on board. So, after 6 artificial deals, it becomes
$1.40 for buy and $1.70 for sell, entirely legal!.)
This will be extremely difficult for an investor to buy at the cheapest
price of the day; or to sell at the highest price of the day.
Also, when there is a big slump market, everyone is dumping on the
stocks, and you can't find any buyer for any low selling price
you are quoting.
(3) No bonus or interest received
Warrant has no bonus or interest received. Normally the annual
interest is only within 3-7% and warrant investors normally
consider it is a fee that covers the interest on the difference
of capital in stock/warrant investment.
(4) Risk of becoming a "WALL-paper warrant"
As explained about, the intrinsic value of a warrant is equal to
the difference between the current price of stock with that of the
strike price. IF the price of the stock falls below that
of the strike price, the intrinsic value of the warrant is zero.
Investors may still however invest on this type of 'ultra-price' warrant,
solely because of it "time value", i.e. there may still be some
chance that the price of stock recovered, and thus still worth-buying.
However if the expiration day of the warrant is coming, no investors
will buy this warrant, as they can simply buy the stocks directly
from the market at a even cheaper price.
The following serves as an example of "Wall-paper warrant":
(553) Dairy Farm (Swiss Bank)
Expiration date : Aug. 01, 1995
Strike price: $12.90
Premium : 51.18%
Leverage : 12.85
Current price of stock: $8.50 (Dec. 23, 1994)
Last dealing price of warrant : $0.45
(but already has no transaction this whole month, no buyer!)
(5) Types of Warrant
In HK there are several types of warrant, and this affects the
strategy in warrant investment.
(a) Ordinary warrant
Ordinary warrant is issued by the stock company itself, and it
is primarily an instrument for the majority holder to maintain
the control over the company.
Taking the Hang Lung warrant (1201) as example, this warrant was issued
this year to the existing share holders at the rate of 1 warrant per 10
shares, in addition to the half year interest issued. Thus the majority
share holder (Chan's family) also gets the majority distribution for the
warrant. In the coming year, suppose if the Hang Lung share goes up to
say $25, the majority holder wants to sell some of his holder to get
profit, WITHOUT losing control over the company, he can simply buy back
the equivalent amount of warrant from the market. In case any
unforeseeable problem arises, he can still exercise the warrant and thus
still gets enough control over the company.
In this consideration, warrant is also often issued as a gift to the share
holders in Initial Public Offer (IPO), because the majority holders
can legally obtain more 'reserved' control over the company by getting
more warrant.
(b) Covered warrant
The main difference between a covered warrant and the ordinary warrant
is that the covered warrant is issued by an INDEPENDENT company,
often an investment banker (like Merrill Lynch, Stanley Morgan,
Peregrine and Jardine Fleming etc.), instead of the stock company itself.
The covered warrant is primarily an investment instrument.
Suppose Stanley Morgan has interest in the New World Development (NWD) and
has started to collect while it was low (say < $10). As a long term investor,
Stanley Morgan can keep the NWD for years without selling it, but then the
capital will be locked up. However Stanley Morgan decided to issue a covered
warrant (1036), which any holder of the warrant can go to Stanley Morgan (not
NWD!) for buying 0.1 share of NWD by exercising 1 warrant of 1036, together with
the amount $29.70 (the strike price of 1036 is 29.70, and the conversion ratio
is 0.1).
(6) Difference between ordinary warrant and covered warrant. As ordinary
warrant is issued by the company itself, the company normally will like to
encourage more investors to inject capital to support the company. In this
consideration, the strike price is normally designed at a REASONABLE price
so that when it is going to expire, the warrant holder is still willing to
exercise the warrant. Blue chip ordinary warrants seldom become 'Wall-paper
warrant'. This factor is quite imp ortant especially when the warrant is
going to expire,> and the price of stock is approaching that of the strike
price. Normally the majority holders will appear and push up the stock
price so as to encourage warrant holders to exercise the warrant. But also
because of cheap strike price, the leverage ratio usually is only around
3-5.
For the covered warrant, the main concern of the issuer is how to attract
the market investors to buy the issued covered warrant when the product
is launched. In this consideration, the usual technique for the
investment banker is to buy lot of the corresponding share at a low
price and suddenly push up the stock price. It then issues the covered
warrant at a strike price based on the high stock price. Often they
will also support the stock price for a while, but when their warrant
have been nearly sold to the market, the stock price will drop.
As the strike price of covered warrant is normally quite high, the
premium and leverage ratio are also quite high. The high leverage
ratio is ideal for investment consideration, but the high premium
is very risky, and the covered warrant can easily become "Wall-paper
warrant" in bad market situation.
Investors should always remember that the issuer of the covered
warrant is an investment banker who is VERY EXPERIENCED in market
manipulation. When a covered warrant is approaching its expiration
date, the issuer will try to beat down the price of the stock,
such that the issuer can buy back enough stock from the market
to be later distributed to the warrant holders who are willing
to exercise the warrant. In the extreme, the issuer may even
try to drag down the stock price to make it lower than the
strike price. The warrant thus becomes 'Wall-paper' and no
warrant holder is willing to exercise it. The warrant issuer thus
makes a neat big profit. This normally occurs to the weaker
blue chips (there is only covered warrants for blue chip stocks
in HK) like Cathay Pacific and Dairy Farm. There are some
issuers who are very NOTORIOUS in killing their covered warrant investors!
(7) Other derived covered warrants
Covered warrant with Cash option
--------------------------------
In the end of last year just before the big rally, some covered warrants
issuers were deeply hurt by some 'super big hands'. The technique
which the 'super big hands' did is:
. keep on buying the covered warrant from the market;
. push up the price of the stock, thus pushing up the price of warrant
also;
. if the issuer is alert and wants to buy back the warrant from the
market, sell the warrant back to the issuer but at a much higher price
due to the high leverage ratio;
. if the issuer takes no action, then the 'super big hands' will try to
exercise the warrant. As the issuer does not have enough share on
hand, it can only buy the share from the market, thus falls
in the trap.
To guard against this, now most of the new covered warrants are issued
with cash option. The issuer can pay the warrant holders cash
instead of the real stock. This saves the issuer from the
potential hazard of being forced to buy stock from the market.
Furthermore, the price of stock for the cash option calculation is
normally based on the average stock price for normally 30 business
days before warrant expiration. This again offers a chance for the
issue to manipulate the price.
Capped covered warrant (European style spread covered warrant)
---------------------------------------------------------------
Theoretically the liability of the covered warrant issuer can be
infinity should the price of the stock goes up continuously.
To set an limit to the maximum liability, there are some newer
warrants issued subject to a capped price, and the warrant
is ONLY to be exercised within a period (normally 1-2 weeks)
immediately after the expiration day. If the issuer desires to
pay cash rather than real share when the warrant holders exercise
warrant, the cash paid is limited to the capped price.
(8) A list of blue chip warrants / covered warrants
issue Conv. Strike
Code Stock Co. Date ratio price
507 Cheung Kong RF 24/02/94 - 27/07/95 0.10 47.500
1109 Cheung Kong CL 01/07/94 - 15/01/96 0.10 37.750
1166 Cheung Kong SGW 30/09/94 - 04/03/96 0.10 39.800
501 China Light UBS 09/03/94 - 07/02/96 0.10 47.250
572 China Light RF 22/03/93 - 24/02/95 1.20 30.000
1099 China Light SGW 27/06/94 - 02/01/96 0.10 41.000
527 HK Gas ML 02/03/94 - 29/01/96 1.20 18.190
607 HK Gas RF 09/12/93 - 16/11/95 1.20 17.500
1052 HK Gas self 01/07/94 - 31/12/95 1.20 15.500
595 Wharf SB 03/03/94 - 02/08/95 0.10 33.000
637 Wharf PED 02/03/94 - 31/07/95 0.10 33.500
58 HKBC SB 09/09/93 - 10/08/95 0.10 81.500
424 HKBC BZW 10/03/94 - 31/01/96 0.10 120.000
573 HKBC PED 22/03/93 - 20/02/95 0.10 63.500
630 HKBC PED 23/02/94 - 02/02/96 0.10 109.000
682 HKBC RF 03/03/94 - 02/02/96 0.10 131.000
768 HKBC PED 10/11/93 - 20/03/95 0.10 79.500
1115 HKBC ML 06/07/94 - 06/03/96 0.10 87.000
1116 HKBC SB 07/07/94 - 08/12/95 0.10 69.500
435 HK Electric SGW 06/03/94 - 06/03/96 0.10 29.200
565 HK Electric RF 06/04/93 - 10/03/95 1.00 17.300
556 HK Land BZW 02/04/93 - 24/02/95 1.00 14.100
982 HK Land SB 20/01/94 - 02/01/96 0.10 23.100
169 HK TeleCom SB 09/12/93 - 18/11/95 0.10 14.000
574 HK TeleCom CIT 09/04/90 - 10/02/95 1.00 4.755
594 HK TeleCom BZW 10/03/94 - 26/01/96 0.10 16.100
705 HK TeleCom RF 21/06/93 - 26/05/95 0.10 11.900
1098 HK TeleCom SGW 22/06/94 - 24/11/95 0.10 15.600
1114 HK TeleCom UBS* 06/07/94 - 01/12/95 0.10 13.300
644 Hang Lung PED 02/03/94 - 24/07/95 0.10 19.000
1201 Hang Lung self 01/01/95 - 31/10/97 1.00 16.000
995 Hang Seng CL 27/01/94 - 14/01/96 0.10 71.500
1120 Hang Seng UBS* 17/08/94 - 17/02/96 0.10 47.500
1163 Hang Seng BZW 02/09/94 - 20/01/96 0.10 55.500
344 Henderson Land SB 02/12/93 - 09/11/95 0.10 28.500
672 Hutchison SGW 25/02/94 - 21/12/95 0.10 36.000
708 Hutchison CL 07/07/93 - 25/05/95 1.00 22.500
1107 Hutchison RF 29/06/94 - 29/11/95 0.10 34.250
394 Hysan SGW 15/10/93 - 06/09/95 1.00 17.000
692 Hysan self 03/05/91 - 31/12/95 1.00 7.980
1038 Hysan PED 14/04/94 - 14/09/95 0.10 25.200
577 J. Math. Hold PED 19/07/93 - 08/06/95 0.10 60.000
695 SHK Land PED 01/06/93 - 04/05/95 0.11 33.410
1084 SHK Land SGW 17/06/94 - 02/01/96 0.10 50.000
1195 SHK Land CIA 27/10/94 - 29/03/96 0.10 56.000
319 New World Dev. self 12/05/92 - 12/05/95 1.00 14.700
381 New World Dev. self 19/04/93 - 05/04/96 1.00 19.500
453 New World Dev. SLM 03/03/94 - 02/02/96 0.10 37.000
1036 New World Dev. MGS 31/03/94 - 23/02/96 0.10 29.700
489 Swire A PED 28/06/93 - 16/05/95 0.10 39.000
631 Swire A RF 18/02/94 - 19/01/96 0.10 62.000
1058 Swire A SCH 12/05/94 - 15/04/96 0.10 53.100
1105 Swire A PED* 29/06/94 - 30/11/95 0.10 55.000
400 Wheelock SLM 10/11/93 - 18/10/95 1.00 15.200
980 Wheelock RF 06/01/94 - 01/12/95 1.00 17.400
979 Bank of E Asia PED 04/01/94 - 23/05/95 0.13 31.800
997 Bank of E Asia PED 14/02/94 - 12/01/96 0.13 42.000
393 Hopewell RF 11/10/93 - 08/09/95 0.10 5.450
1121 Hopewell CIA 17/08/94 - 26/01/96 1.00 6.500
61 Sino Land self 01/01/93 - 31/10/97 1.10 7.270
1164 Henderson Dev. CL 12/10/94 - 16/09/96 0.10 6.525
576 Amoy Prop. self 01/01/93 - 31/03/95 1.00 7.200
1181 Con. Elect. PA PED 12/10/94 - 16/09/96 0.10 15.500
523 Dao Heng Bank SGW 28/02/94 - 25/01/96 0.10 32.000
482 CITIC CIA 11/03/94 - 07/08/95 1.00 26.500
596 CITIC RF 04/11/93 - 13/10/95 0.10 18.800
1165 CITIC SGW 09/09/94 - 12/02/96 0.10 22.600
1194 Guangdong Inv. NMI 27/10/94 - 26/03/96 0.10 4.725
459 Dairy Farm SLM 15/06/93 - 24/05/95 1.00 12.900
553 Dairy Farm SB 01/09/92 - 01/08/95 1.00 12.400
* Capped warrant
Issuer
------
self Issued by the Co. (i.e. ordinary warrant)
BZW Barclays de Zoete Wedd Warrants Ltd.
CIA Carr Indosuez Asia (Derivatives) Ltd.
CIT CITIC
CR Credit Lyonnais Finance (Guernsey) Ltd.
ML Merrill Lynch Int'l & Co.
MGS Morgan Stanley (Jersey) Ltd.
NMI Nomura International (HK) Ltd.
PED Peregrine Derivatives Ltd.
RF Robert Fleming & Co. Ltd.
SB Swiss Bank Corp. HK
SCH J. Henry Schroder Wagg & Co. Ltd.
SGW S.G. Warburg OTC plc
SLM Salomon Inc.
UBS Union Bank of Switzerland
Capped price
1114 20.40
1120 75.50
1105 86.00
[The following high/low refers to the period from 1994-01-01 to the date
indicated]
Stock Price Warrant Price Premium Leverage
Code high 23/12/94 low high 23/12/94 low ratio
507 52.00 26.30 25.90 1.380 0.135 0.126 85.74% 19.48
1109 52.00 26.30 25.90 1.150 0.350 0.335 56.84% 7.51
1166 52.00 26.30 25.90 1.130 0.440 0.410 68.06% 5.98
501 57.00 31.10 29.80 1.350 0.320 0.232 62.22% 9.72
572 57.00 31.10 29.80 32.750 2.625 1.920 3.50% 14.22
1099 57.00 31.10 29.80 1.235 0.360 0.275 43.41% 8.64
527 22.17 11.80 10.80 5.400 0.900 0.370 60.51% 15.73
607 22.17 11.80 10.80 9.500 0.600 0.370 52.54% 23.60
1052 22.17 11.80 10.80 5.350 1.070 0.820 38.91% 13.23
595 41.00 21.60 21.20 0.990 0.126 0.103 58.61% 17.14
637 41.00 21.60 21.20 0.960 0.106 0.100 60.00% 20.38
58 131.00 77.75 76.25 6.500 1.020 0.940 17.94% 7.62
424 131.00 77.75 76.25 2.900 0.385 0.320 59.29% 20.19
573 131.00 77.75 76.25 7.150 1.380 1.270 -0.58% 5.63
630 131.00 77.75 76.25 3.600 0.470 0.430 46.24% 16.54
682 131.00 77.75 76.25 2.600 0.320 0.250 72.60% 24.30
768 131.00 77.75 76.25 5.900 0.510 0.475 8.81% 15.25
1115 131.00 77.75 76.25 2.520 0.820 0.760 22.44% 9.48
1116 131.00 77.75 76.25 3.450 1.790 1.700 12.41% 4.34
435 35.50 21.15 18.70 0.780 0.160 0.116 45.63% 13.22
565 35.50 21.15 18.70 17.800 3.900 2.475 0.24% 5.42
556 31.75 14.05 13.80 17.000 0.930 0.890 6.98% 15.11
982 31.75 14.05 13.80 1.800 0.174 0.154 76.80% 8.07
169 17.70 13.30 12.00 1.400 0.250 0.241 24.06% 5.32
574 17.70 13.30 12.00 13.600 8.300 7.450 -1.84% 1.60
594 17.70 13.30 12.00 0.390 0.146 0.140 32.03% 9.11
705 17.70 13.30 12.00 0.865 0.235 0.230 7.14% 5.66
1098 17.70 13.30 12.00 0.470 0.148 0.148 28.42% 8.99
1114 17.70 13.30 12.00 0.400 0.174 0.166 13.08% 7.64
644 21.90 10.40 10.10 0.550 0.054 0.035 87.88% 19.26
1201 21.90 10.40 10.10 1.430 0.920 0.550 62.69% 11.30
995 80.50 47.80 47.40 2.925 0.470 0.350 59.41% 10.17
1120 80.50 47.80 47.40 1.385 0.930 0.880 18.83% 5.14
1163 80.50 47.80 47.40 1.480 0.660 0.630 29.92% 7.24
344 60.50 33.60 32.50 4.150 1.010 0.970 14.88% 3.33
672 42.50 25.40 24.75 1.330 0.305 0.290 53.74% 8.33
708 42.50 25.40 24.75 23.900 5.300 5.000 9.45% 4.79
1107 42.50 25.40 24.75 1.075 0.320 0.290 47.44% 7.94
394 33.25 13.85 13.40 15.200 1.300 1.370 32.13% 10.65
692 33.25 13.85 13.40 24.600 6.250 6.000 2.74% 2.22
1038 33.25 13.85 13.40 0.860 0.091 0.050 88.52% 15.22
577 84.50 54.50 46.75 3.700 0.680 0.380 22.57% 8.01
695 77.00 38.60 37.80 6.250 0.930 0.850 8.46% 4.57
1084 77.00 38.60 37.80 2.020 0.580 0.550 44.56% 6.66
1195 77.00 38.60 37.80 1.480 0.295 0.285 52.72% 13.08
319 42.50 18.00 17.80 27.200 4.325 4.000 5.69% 4.16
381 42.50 18.00 17.80 24.400 3.800 3.400 29.44% 4.74
453 42.50 18.00 17.80 0.930 0.097 0.050 110.94% 18.56
1036 42.50 18.00 17.80 0.940 0.150 0.110 73.33% 12.00
489 71.00 40.70 40.20 3.975 0.680 0.630 12.53% 5.99
631 71.00 40.70 40.20 1.970 0.320 0.280 60.20% 12.72
1058 71.00 40.70 40.20 2.600 0.600 0.520 45.21% 6.78
1105 71.00 40.70 40.20 1.460 0.238 0.226 40.98% 17.10
400 23.50 10.70 10.50 11.200 0.920 0.830 50.65% 11.63
980 23.50 10.70 10.50 13.400 0.920 0.650 71.21% 11.63
979 50.00 28.10 27.20 5.000 0.570 0.310 29.40% 6.16
997 50.00 28.10 27.20 1.950 0.550 0.305 65.12% 6.39
393 10.80 5.35 5.25 0.600 0.102 0.990 20.93% 5.25
1121 10.80 5.35 5.25 2.375 0.710 0.670 34.77% 7.54
61 13.64 4.98 4.85 8.500 1.590 1.550 75.19% 3.44
1164 9.80 4.43 4.15 0.290 0.054 0.050 59.66% 8.19
576 15.60 6.55 6.35 8.200 0.435 0.400 16.56% 15.06
1181 19.10 13.05 9.15 0.760 0.300 0.300 41.76% 4.35
523 34.75 16.90 16.80 0.890 0.146 0.128 97.99% 11.58
482 27.20 14.80 14.70 5.800 0.305 0.290 81.11% 48.52
596 27.20 14.80 14.70 1.260 0.213 0.196 41.42% 6.95
1165 27.20 14.80 14.70 0.860 0.430 0.320 81.76% 3.44
1194 6.15 3.38 3.03 0.170 0.049 0.045 54.52% 6.89
459 16.20 8.95 7.75 5.450 0.240 0.100 46.82% 37.29
553 16.20 8.95 7.75 5.950 0.450 0.430 43.58% 19.89
(9) Final Comment
As listed in the above table, most of the blue chips warrants are
now at their bottom, which is only less than 20% of their highest
price around February 1994. Thus if the HK market can go back to
11000 points at the end of 1995 (which may be something that is not
far from realistic), these warrants may bring a 300-400% profit
to the investor. In fact, for those brave investors who managed to buy
these warrants during the last big slump, they have already had a 100%
profit! But in view of the possible coming rate hike, all those warrants
to be expired before June 1995 should not be considered.
PLEASE remember the first principle in warrant investment.
Always look from the perspective of the stock first. If the stock rises,
the warrant will rise, the difference is only in the magnification
ratio. But NEVER invest in a warrant without first looking into its
corresponding stock. A warrant can have a very attractive long expiration
date, very low premium and also high leverage ratio, but if the stock
is weak, don't touch it.
InTechTra, Inc. 1995-01-11
-END-